Government Interventions Flashcards
How do govs use regulation to prevent market failure?
Gov places laws and regulations which prohibit certain behaviours and actions. Some examples of these are limits on the amount of pollution engines can create (in US, Motor Vehicle Air Pollution Act set standards for the first time about levels of pollution and emission from cars) or banning diesel cars from city centres (like Paris) or age regulations for alcohol, etc.
What some evaluation of regulation?
+ simple and easy to understand
+ a legal ban sends a clear signal that it is wrong (e.g. diesel cars)
+ in the case of emissions, regulation can encourage firms to innovate and invest in green technology
- socially inefficient (e.g. banning cars in city centres would reduce pollution, but could have adverse economic effects on businesses)
- costs and difficulties in enforcing many restrictions and regulations
How do govs use subsidies to prevent market failure?
Subsidies are payments from the gov to producers to reduce their overall costs of production
- it should ultimately lead to an increase in the quantity brought and sold - solving the problme of under-production/under-consumption
—> supply increases and shifts right on a diagram and therefore demand extends as price demands and quantity increases - more people willing and able to buy the product
What’s some evaluation for subsidies?
- depends upon elasticity of demand for a product - when Inelastic, the subsidy is relatively ineffective
- they are also very expensive for the gov so total benefits need to outweigh the total costs
- difficult to judge how big to make a subsidy so gov failure doesn’t occur - it should ideally be equal to tax
How do govs use indirect taxes to prevent market failure?
Govs can introduce an indirect tax on a product in order to reduce the quantity brought and sold. This might be used to deal with over-production/over-consumption of products with negative externalities. An indirect tax is placed on suppliers, increasing their costs of production
- as a result of tax on suppliers, supply decreases and shifts left leading to an increase in the price, also meaning demand contracts (as some consumers will now be unable or unwilling to purchase the product) therefore quantity brought and sold reduces
What’s some evaluation of indirect taxes?
+ raises government revenue
- difficult to know how big the tax should be (in theory, the tax should be equal to the size of the external cost - this internalises the external cost)
- effectiveness of tax depends upon the elasticity of demand - elastic: highly effective in decreasing demand quantity, Inelastic: relatively ineffective in decreasing quantity
How does the gov use minimum prices to prevent market failure?
- also known as a price floor
Gov establishes a legal minimum price above market equilibrium, thus raising the price of the product. New higher price leads to a contraction in demand which means less of the product is being brought and sold. However the new higher price does create an extension in supply, encouraging an inefficient excess supply/surplus - distorting the market.
What’s some evaluation for minimum prices?
- leads to an imbalance in the market, as minimum pricing will cause supply to outweigh demand - even though consumers will buy less, firms are encouraged to sell more due to the prices being higher
- emergence of the black market, if this price is extreme enough, it can encourage black market activity - costly for society (increase in criminal activity). Also cost gov to police this
- depend on elasticity of demand as it can have an effect on the effectiveness of the policy
- wont effect the rich as much, creating more inequality as the poor will need to pay a bigger percentage of their income
- also an error in calculating the socially efficient level of output will mean the minimum pricing policy can be wrongly implemented by the gov - my be too high or not high enough
How do govs use maximum prices to prevent market failure?
- also known as a price ceiling
Gov establishes a legal maximum price below the market equilibrium, thus reducing the price of the product. Important where consumers are being exploited by a monopoly - where the consumer of a good is encouraged. They have to set prices below the free market price (equilibrium), otherwise they would be ineffective. (E.g. rent controls or key food products). The newer price leads to an extension in demand, however a contraction in supply - leading to potential shortages, waiting lists and possible black markets. This distorts the market
What’s some evaluation of maximum prices?
- distorts the market and leads to a disequilibrium
- demand greater than supply meaning many consumers will be unable to get the product at all - cheap rents are no good if it leaves people homeless
- creates an incentive to develop a black market where people illegally trade the good - people can buy at a low price and resell for more money.
- market will become less profitable for firms - in the long term, may lead to less investment and decrease supply (e.g. reducing rent will discourage landlords from renting)
—> long term solution is to build more affordable housing - not just rely on maximum prices - most useful in case of monopoly who is restricting supply and inflating prices
How do govs use provision to prevent market failure?
The gov can provide public goods, which are unprovided in the free market, such as lamposts. This makes merit goods more accessible, which will increase their consumption and yield positive externalities
What’s the evaluation of provision?
- redistributes income and wealth, tax money that comes in from the rich people is used to pay goods/services that poorer people are unable to afford - helps lessen inequality
- increases consumption of public goods
- gov does not have the correct info all the time, so excess demand/supply is more probable - the gov can get away with not understanding the costumers needs - leads to a misallocation of resources and not satisfying needs and wants.
- tax payers money is spent on this, creates an opportunity cost in that there is less money available to spend on other projects
- reduces independence of consumers, if the gov is too relaxed, it can attract unwanted behaviour (e.g. overuse of the NHS, people learn to expect free healthcare and take way too much advantage of this)
How does the gov use correcting info failure to prevent market failure?
By providing info, govs can ensure that there is no info failure, so consumers and firms can make informed economic decisions. This can be through accurate labelling (e.g. requiring alcoholic content is labelled clearly on drinks). Public broadcast, such as public service and radio broadcasting.
Laws may be passed to force public limited companies to be more transparent, e.g. publishing their accounts.
Advertising is very informative
Another would be govs making it illegal for second hand car dealers not to reveal the entire history of the car, so consumers know what they are buying
What’s some evaluation of correcting info failure?
- inevitable in a world of product complexity
- the paradox of choice (choice overload) can distort our decisions as most people have bounded self control
- fake news and misleading advertising damage consumer sovereignty and leads to loss of allocative efficiency
- important to link info failures to externalities
- info failure can effect equity (e.g. students from poorer backgrounds finding it harder to access best unis)
- hard to avoid making value judgement (e.g. what would be classes as a demerit good)
- behavioural interventions can make a different but hard ‘nudges’ may be needed in certain situations, such as having compulsory vaccination enrolments, so people understand its best.
