Government Policies To Achieve Efficient, Resource Allocation And Correct Market Failure

Question 1

Negative production externalities

Answer 1

1. Indirect tax
   > Example, a firm’s production process leads to pollution to the environment.
   > An indirect tax will be imposed on firms, this is consistent with the ‘polluter-pays’ principle.
   > Tax imposed ideally equal to MEC.
   > This tax is therefore added into the cost of production, and the supply curve shifts inwards to S2, which is equal to MPC + Tax.
2. Regulations
   > Rules and laws and other range of legal requirements that come from the government or other organisations.
   > Government could set standards that restrict the amount of pollution that can be legally produced.
   > Government would then regulate and inspect the firms to ensure those restriction are enforced.
   > Government can also set laws that limit carbon emission from automobiles. Example, Europe’s cars.
3. Pollution permits
   > A form of licence given by the government that gives firms the legal right to pollute a certain amount per year.
   > A free market solution as it can be bought and sold.
   > Issued by the government under Emission Trading Scheme (ETS), European Union (EU).
   > The USA has recently introduced a ‘cap and trade’ system for reducing carbon emission.
   > Create incentives for businesses to invest in clean technologies.
   > Limitation is that in 2005, EU governments allocated too many permits.
4. Property rights
   > Owners have the right to decide how their assets may be used.
   » The exclusive authority to determine how a resource is used.
   » Individuals, firms, governments and others have the rights to own resources such as housing, factories, farms.
   > Gives the owner the legal rights to use the property and can enforce the property rights accordingly.
   » Advantage to the owners.
   > Bargaining can be undertaken to achieve an optimum level of pollution.

Question 2

Negative consumption externalities

Answer 2

1. Indirect tax
2. Minimum price
   > Fiscal device by imposing minimum price on products that generate negative consumption externalities.
   > Go more on MPB to MSC.
   > This intervention occurs in many countries to limit the consumption of high-sugar energy drinks and tobacco products such as cigaretts.
   > The minimum price increases the price to consumers above the point where MPB = MSC.
   > The effectiveness of this policy depends upon the price elastcity of demand for the product.
   » In the case of demerit goods, demand is invariably price inelastic.
   » This will affect the success of a minimum price scheme.
   » Elastic is more effective, consumers are very responsive, they will reduce quantity demanded by greater amounts when price increases. When quantity is reduced, it can solve externalities.
   » Inelastic is not so effective as the consumers are less responsive, quantity will decrease less.
3. Production quotas
   > Involves limiting the quantity of goods that is produced.
   > If the quota is set at a low level, the price of the product is likely to rise, reducing the amount consumed.
4. Licensing suppliers
   > Used to control supply.
   > One problem is that they can lead to informal market dealings.
   > Example, cigarette production.
5. Legislation
   > To enforce the laws.
   > Examples, prohibit smoking in the public, limit the automotive noise.
6. Provision of information
   > Warning and photos in tobacco packets to deter smoking, information provided on food packaging, provide carbon footprint when travelling.

Question 3

Positive production externalities

Answer 3

1. Subsidy
   > Subsidies that equal to external benefit to correct market failure.
   > Allocative efficiency is now achieved.

Question 4

Positive consumption externalities

Answer 4

1. Subsidy
   > Provided by the government shifts the supply curve outwards.
   > As such, the marginal cost of supplying the product is reduced by the amount of subsidy.
2. Legislation
   > Used in some countries to make state-funded education compulsory up to a certain age.
3. Information
   > Provided by the government to persuade consumers to consume goods that produce positive externalities, example, exercise to reduce health issues.

Question 5

Behavioural insights and ‘Nudge’ theory

Answer 5

1. Nudge theory argued that by presenting choices better, people make wiser decisions without losing their freedom of choice, and avoid the need of formal government intervention.
2. People can be helped to think appropriately and make better decisions by being offered choices that have been designed to reach certain outcomes.
   > Design for the improvement of society without the need of regulations.
3. it is a ‘soft paternalism’ whereby the government or individual interfere with the affairs of people against their will yet with their best interest in mind.
   > Example, free vaccination that is available to senior citizens. These people can be targeted by a simple letter that makes them dully aware of the benefits of having vaccination.
4. Effectiveness of nudge
   > Nudge theory can be debated between persuasion and coercion.
   > It is not transformative, Choices are influenced by changing the context, not attitude or beliefs.
   > Nudge works but to only a limited extent. It is best used and most effective when used alongside other policies that are already dealing with similar market failure.

Question 6

Privatisation

Answer 6

1. Change in the ownership from public to private sector.
2. Reasons for privatisation:
   > To break up monopoly power and produce greater allocative and productive efficiency.
   > X-inefficiency where the costs are above those experienced in a competitive market.
   » Overtime, nationalised company cost levels are higher, leading to average cost and subsequent consumer prices to increase than those under private ownership.
   » This relates to property rights issues where there is little or no pressure on firms to be more efficient.
   > In a private business, managers have freedom to manage and raise funds for investment without restriction from the government.
   > In the case of natural monopoly, it is more practical to have one provider of railway line to avoid duplication and inefficiency.
3. Disadvantages of privatisation:
   > Could lead to private monopoly.
   » Firms are still inefficient.
   > Regulations and controls are still needed to protect consumers from market power from large companies.
4. Whether an industry is privatised or retains state control is often a political decision and not solely on economies grounds.

Question 7

Government failure in microeconomic intervention

Answer 7

1. Government policies to correct market failures (negative externalities) make economic sense.
   > They increase economic efficiency in the markets and are judged to be economically desirable.
2. Causes of government failure
   A. Information failure
   > Lack of information about the true cost or value of a negative externality.
   » It is often very difficult to give an accurate figure for the cost of a negative externality, such as air pollution.
   » The problem is that it becomes very difficult to impose the correct value of a tax that attempts to reduce production of a polluting firm.
   » The wrong level of tax will lead to the wrong level of production and an even greater inefficiency in the use of resources.
   > Lack of information about the consumer demand for a merit good such as free healthcare.
   » If the government is providing a product free of charge to the consumers, some estimation of the level of consumer demand is required.
   » This is necessary in order to establish the cost of the intervention.
   » This problem also occurs with the provision of public goods.
   » The government must try to provide the right amount of such goods.
   » If it does not estimate the level of demand accurately, then the wrong amount will be produced or funded.
   » This is another case of an inefficient allocation of resources.
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   B. Unintended consequences
   > The imposition of taxes can distort incentives.
   » High marginal rates of income tax can create disincentives for people to work harder and so gain more income.
   » If this happens, then scarce resources are not being used to their best effect and there is inefficiency.
   > The government pays benefits to unemployed workers.
   » If the benefits paid are too high, there may be no incentive for the unemployed to look for work.
   > Politicians are often seen as being motivated by the desire to remain in government.
   » If this is so, then economic policies may be designed by the governments to try to retain power rather than to try to ensure maximum economic efficiency.
   » For example, road pricing is a very unpopular tax in the eyes of car users, despite its tremendous potential to reduce congestion and hence correct market failure.
   » It is likely to be avoided due to a gvernment’s fears that its introduction could lead to a loss of electoral votes.
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   C. Policy conflicts
   > Government intervention in the running of the economy is often justified by the need to reduce inequality.
   > Government intervention might sometimes increase existing inequality.
   » The imposition of any tax will have a distributional impact.
   » For example, a tax on energy use that aims to reduce harmful emissions of greenhouse gases will have different effects on different groups of people.
   » If the tax is on domestic fuel, then older members of society may bear the greatest effect as they use proportionately more fuel for heating than others in society.
   » This could be seen as unfair and increasing inequality in society.
   > In the case of subsidies on the costs of fossil fuels.
   » These encourage production and their use in coal-fired power stations, both of which contribute increased environmental pollution.
   » The subsidies might enhance the competitiveness of manufacturing industries and keep workers in jobs, but they are completely inconsistent with the need for more sustainable development policies.