Govt intervention Flashcards
Regressive tax
A tax which takes a larger percentage of income from low-income earners than from high-income earners. The tax is assigned regardless of income.
Also occurs when a good that poorer people consume more is taxed such as cigarettes or alcohol
What is Value added tax (VAT)
Is a consumption tax that is levied on a product repeatedly at every point of sale at which value has been added.
What is VAT in the UK
20%
Problem with a VAT
It is a flat tax meaning All consumers regardless of income pay the same percentage. Lower income earners may be effected harder
What does a VAT exclude
The rate is reduced to 5% on certain purchases such as children’s car seats and home energy. There is no VAT on some items such as food and children’s clothing. Financial and property transactions also are exempt.
Define market failure
the misallocation of scarce resources
say 4 ways in which market failure can be caused
- the existence of externalities (positive or negative)
- inequality
- information failure
- Monopoly Power – when a firm controls the market (with high market share) and can set higher prices.
how is the rationing function caused
- when demand outstrips supply causing prices to rise
what does an increase in market prices signal
1 for suppliers
2 for consumers
- for suppliers it signalls them to increase supply of products
- for consumers it may encourage them to choose cheaper alternatives
Benefits of taxes
- internalises the externality
- can gain tax revenues which can be used to reinvest and hypothecate the externality
- may cause firms to become more innovative in production to keep costs low
3 evaluation points of indirect taxes
- if demand is price inelastic consumption may not decrease
- hard to assign correct level of tax as govt has imperfect info
- can cause unemployment as demand for the product falls.
- may reduce dynamic efficiency in the long term as revenues are smaller
what is a subsidy
- An amount of money provided to firms to help reduce production costs
- as firms can now produce at a lower cost they may be more willing and able to lower prices ( as they can maintain profit margins) in order to attract demand
- This may encourage consumers to buy a good which has positive externalities assuming the demand is price elastic
3a. by providing more substitutes (public transport) to a good (cars) the PED for cars may decrease and consumers may become less reliant on these goods as a result
direct tax
taxes on incomes, wealth and profit
(this tax burden that cannot be passed on)
eg income tax
indirect tax
taxes on consumption
4 evaluation points of subsidy
- opportunity cost (money may be better invested in healthcare)
- may be hard to set at the right level
- firms may not use this subsidy for good use
- may create over reliance
3 evaluation points of income taxes
- can cause a brain drain (ireland has lowest tax)
- increased tax avoidance
- can decrease the incentive to work
evaluation of free provision of services such as NHS or libraries
universal provision is not as effective as targeted provision.
Eg some areas in Cambridge may be better educated with heavier investment into school and may not need libraries. Whereas an area such as Glasgow north east
Government failure definition
when an intervention leads to deeper market failure or new market failure is caused
causes of govt failure
- myopia -short termist views in order to win elections (may 2 2024)
- info failures
- regulatory capture
- if the laws are not enforced
what is internalising externalities
taxation attempts to make the producer pay for the full cost of externalities
evaluation of pollution tax
- can stunt growth
2. has to be a universal tax to ensure no economy in unfairly treated
evaluation of an indirect tax
if the good is inelastic make consumers pay for the whole price of the tax. which can be regressive and widen inequality.
what is maximum pricing
it is the highest price that a firm can set the price is usually set below equilibrium
- may be used to lower supply of a good
- may be used to increase consumption
what are property rights
a legal right of ownership over a resource
Why may property rights benefit the environment
there is better incentive to maintain the resource as firms are profit maximisers
if producer have their own resource they are less likely to overexploit this for short term profits. instead they may better manage the resource to avoid extinction and guarantee longevity and sales in the future
Why might the government intervene
When the invisible hand is not effective in allocating the socially maximum equilibrium
the government should only intervene if the externalities created is larger than the opportunity cost that government intervention costs.
What are the 4 economic assumptions
- There are unlimited want but limited resources
- There is an opportunity cost to every decision
- each consumer seeks to maximise their satisfaction
- The consumer is rational and will consider all costs and benefits before making a decision (homo economicus)
what’s the goal of market economies
to maximise profits
what’s the goal of public economies
to maximise social welfare and allocatively efficient
what negative impacts may a market have if it is run by the government
(command economies)
- poor variety
- lack of innovation to cut down prices
- slower to react to changes in demand
why do consumers over consume some demerit goods
- goods may have addictive properties
- information failure (undervalued long term impacts
- social norm
what is the diminishing marginal utility
the decrease in satisfaction a consumer has by consuming an extra good or service
what does diminishing marginal utility show
why the demand curve is downward sloping
why does rising incomes leas to diminishing marginal utility
- if you have zero income then the first 100 means a lot as it finances food ect
- if you are earning 1000’s an extra hundred has less of an impact as it can’t improve standard of living to the extent that the first 100£ did
how to work out tax revenue on the diagram
work out the size of the tax per unit. (vertical distance between the two supply curves)
the times it by the quantity where the tax is implemented
how does an indirect tax cause an inward shift in supply
it increases the cost of production
define market failure
This occurs when there is an inefficient allocation of resources in a free market
what is the tragedy of the commons
where the is overconsumption of a common resources because rational decisions lead to an outcome which is damaging to overall welfare.
why does the tragedy of the common occur
because everyone maximises utility
eg. If one individual fisherman holds back on his catch to try and preserve overall fish stocks, it may prove futile because many other fishermen continue to catch as much as possible. The net result is that fisherman don’t have any incentive to hold back, so they might as well try and catch as much as possible.
how can government intervention help overcome the tragedy of the commons
- limit fish catches
- prevents fishermen from exploiting the seas to maximise profit as they risk a large a fine or other punishment otherwise
evaluation of government regulation
- if there is appropriate enforcement (if nobody checked speed cameras everyone would speed)
- depends on what the punishment is (if you only had to pay a pound for speeding you would)
This process is expensive (eg setting up speed cameras on every road in the UK)
how can property rights help overcome the tragedy of the commons
- if a common land is given ownership, the owner is given better incentive to manage the resource
- in order to make long term profit
evaluation of property rights in order to overcome the tragedy of the commons
the owner may be pressured by shareholders to increase profits and satisfy short term goals. this may result in the same problem
free rider problem
when individuals can consume a good without paying. A person may be unwilling to pay for a good if they may already benefit from this good without paying.
This is why public goods are not provided in the free market.
why is the free rider problem so likely
because individuals are rational utility maximisers and will look to benefit from a public good without having to pay for it.
what are ways information can be provided to combat obesity
eg the number of calories a meal is now displayed in restaurants so consumers can make the correct decision
Adverts to parents
examples of industries that suffer from regulatory capture
OFGEM- office of gas and electricity markets
oil and gas drilling regulators in the US- made it easier to drill in offshore areas.
how may regulatory capture occur
- bribery and corruption
- Spending time with people makes you more sympathetic to their viewpoint. If the regulator is in close contact and communication
consumer surplus
the difference between the price that consumers pay and the price that they are willing to pay
how can firms reduce consumer surplus
if the are a monopoly or have brand loyalty they can charge higher prices
producer surplus
the difference between the price a firm receives and the price it would be willing to sell it at.
what is regulation
Rules or law implemented by the government that must be abided by economic agents to encourage change in behaviour
examples of regulation
- no diesel cars by 2030
- public smoking ban (can’t smoke in enclosed areas)
- deposit return scheme (people are charged higher prices for plastic but are given some money when recycled)
evaluation on a ban of an inelastic good
a ban on a good such as cigarettes which has addictive properties isn’t likely to stop a smoker from smoking. they are just going to do it somewhere else
evaluation of the deposit return scheme
rubbish
- Some consumers may be too lazy/ busy to return their goods and the money that they could be given is too little for the utility they gain by staying at home (spending more time with family)
- some consumer may not need the money and therefore may not be attracted to recycle
what is a pollution permit
Pollution permits involve giving firms a legal right to pollute a certain amount. The aim is to provide market incentives for firms to reduce pollution
If firms pollute less than expected they can sell them creating a market
problems with using pollution permits
- similarly to taxes its hard to assign the right level of pollution permits.
- Pollution permits may be unfairly allocated. those high profit making firms will buy all permits and may increase barriers to entry as new entrants can’t pollute which may be required in some industries
- must be international
THEY SHOULD BE PHASED OUT OVERTIME TO REDUCE THE RELIANCE and to encourage long run incentive in green tech
positive externalities of consumption
when the consumption of a product has benefits to the third party
draw graph showing positive externalities of production
nice
examples of goods with positive externalities of consumption
- libraries
- public transport
- vaccinations
- pensions- if saved for own pension you are not a burden on the state and income tax may not increase
draw the positive externality subsidy graph and explain why subsidies may be required
because in a free market people ignore the third party effects on society (these effects can be positive or negative) and they instead focus on maximising personal utility
a subsidy lowers the cost of production and allows firms to increase supply for the same cost which may lower the price.
as goods are cheaper consumer may be more willing to consume a merit good
why may information provision fail
may not care about information
- despite acknowledging all possible externalities a consumer may be unwilling to buy the product as it may be expensive
- bounded rationality
EG optimism biased. when someone gambles they assume the likelihood of winning is greater than losing.
eg herd behaviour when smoking.
- addicted
how does information provision work
- for example there has been increased concern with the amount of sugar consumption in the UK. (the number of diabetes cases over the past years has increased by 150,000)
- by showing consumers the amount of sugar content on each food/ drink item they may be less likely to consume a product as they may be better aware of the likely effects on their body it may have
- as a result they may consume less and the negative externalities may be avoided
- this policy may be relevant is accompanies with education so people are aware of how damaging a quantity of sugar may be or behavioural nudges.
what is an example of public goods that are provided by the private sector
- local communities may provide private policing
2. local communities may fund parks and gardens
draw min and max price (price cap on energy) diagram
min price- an increased prices results in a contraction of demand as certain consumers may be less willing and able to pay the price at PMIN and consumption of demerit good may fall as a result
Max price- a fall in prices below the equilibrium creates an expansion in demand as more consumer become willing and able to buy the product at PMAX. The product is now demanded at QD and more positive externalities may be created following this increase in demand
examples of goods with positive externalities of production
- eg local businesses will benefit from a local airport from being built
- renewable energy has little cost to air pollution and the increased respiratory diseases associated with it can be avoided
why may a min price be implemented
- to prevent consumption
- to protect suppliers for exploitation
(for example Tesco have buyer power over farmers and a min price prevent exploitation)
evaluation of pricing ceilings
- a maximum price may prevent a firm innovating as they are unable to charge a higher price. this may cause excess demand and shortages
- may be relevant in industries with high monopoly power
examples of goods that have price ceilings
draw price cap on monopoly diagram
- pharmaceuticals
- housing (rent control)
- necessities such as food and renewable energy
NHS diagram
resulting in excess demand. as a result staff may be unable to cope with increases in appointments and the waiting list may be too long as a result.
the supply curve is inelastic as there is a set budget for NHS spending each year and it can’t be exceeded.
benefits of state provision
- makes merit goods more accessible.eg the increased consumption of education (more people going to school) may mean people gain better transferrable skills such as numeracy and literacy skills.
this may improve the quality and quantity of the workforce and in the future output may increase as employees are better skilled.
problems with state provision
- can cause excess demand. Eg in the NHS longer waiting lists in schools bigger classes
(in the free market this may not be a problem as prices will rise to ration the excess demand) - opportunity cost may be caused (of other spending and debt interest payments) and it may be expensive
evaluation of state provision
- assumes the govt has perfect knowledge and can assign the socially optimum level of output. however this is not the case and the quantity won’t be at QSO resulting in govt failure
- highly inefficient as there is no profit motive and cost may increase
what determines the size of market failure
- degree of ignorance
- how bad the product is for us
- how bad is it affecting other people
examples of negative externalities of production
- car journeys
2. fossil fuels
example of moral hazard
eg if free school meals were provided those who could afford meals will rely on the government as it is cheaper and as a result the quality may decline as the food is more highly demanded
why does the free market over provide goods with a negative externalities in production
draw diagram
- the market does not allocate in a way to maximise social benefit and as a result the market may over provide at Pfm (such as car journeys)
- this occurs as a result of self interest
(eg herd behaviour) - producers only have to pay the cost of P1 where as the full social cost is p3 because someone else pays the external costs other producers ignore it.
- this creates welfare loss as for every unit produced after qso the cost to society is greater than the benefit
