Market Failure

Question 1

Name 2 Pros of an Indirect Tax

Answer 1

• Helps solve Negative Externalities
• Internalises the Externality- No-one pays unfairly
• Promotes allocative efficiency
• Generates Government revenue

Question 2

Name 2 Cons of an Indirect Tax

Answer 2

• Higher Costs of Production can be passed on to consumers- potentially causing Inflation
• Reduces Consumer Surplus and increases Deadweight Loss to society
• Inelastic demand leads to unresponsiveness to changes in Price
• Governments do not perfectly internalise the externality every time, due to imperfect information
• Unintended consequences, like black markets, unemployment, ‘Brain-Drain’
• Regressive nature of the tax
• Government Failure arguments
• Quite paternalistic and invasive, choice falls

Question 3

What are some of the Evaluation points for an Indirect Tax?

Answer 3

• PED of the good
• The Government revenue can be used as a ‘hypothecated’ tax, where revenue can further solve market failure
• Policy used in compound, what else can be used?
• What level is the tax set at?

Question 4

Name 2 Pros of a Subsidy

Answer 4

• Helps solve Positive Externalities
• Promotes allocative efficiency and societal welfare gains

Question 5

Name 2 Cons of a Subsidy

Answer 5

• Cost of the Subsidy to the Government, Government Failure
• Spending cuts and increased taxation or debt interest
• Opportunity Cost of Providing this subsidy
• Governments often under-subsidise or over-subsidise due to imperfect information, either causing reliance on the subsidy or not correction
• No guarantee that firms will act in the way that this is intended
• Inelastic demand means people won’t drastically increase consumption

Question 6

What are some of the Evaluation points for a Subsidy?

Answer 6

• PED of the Good
• Opportunity Cost of Government spending
• Policy used in compound, what else can be used?
• What level is the subsidy set at?

Question 7

Name 2 Pros of Regulation

Answer 7

• Non-Market based approach, thus when the Market mechanism has failed, this is useful
• No dependence on PED
• Can solve any kind of Market Failure
• Allocative efficiency and welfare gain

Question 8

Name 2 Cons of Regulation

Answer 8

• Costly to enforce the regulation
• The administrative cost of creating the regulation
• Unintended consequences like ‘Brain-Drain’, unemployment, increases costs, black markets, cheats of the regulation
• Government Failure argument

Question 9

What are some of the Evaluation points for Regulation?

Answer 9

• Level the regulation is set at
• Policy used in compound, what else can be used?
• Is there strong enforcement of Regulation?
• Value judgement on the level- what’s ‘Fair’

Question 10

Name 2 Pros of a Minimum Price (Price Floor)

Answer 10

• Reduces the consumption of demerit goods
• Ensures that consumers aren’t harmed by price changes
• Internalised Externality
• Allocative efficiency and societal gain

Question 11

Name 2 Cons of a Minimum Price (Price Floor)

Answer 11

• Regressive nature, increasing the income inequality
• Alternative suppliers cause black markets and smuggling from abroad
• Government loses out as there is a loss in tax revenue
• Unintended consequences, of buying surpluses, leading to Government Failure
• Inelastic good may not properly sort the market failure due to disproportionate fall in Qd

Question 12

What are some of the Evaluation points for a Minimum Price (Price Floor) ?

Answer 12

• PED of the good
• Government failure arguments
• Policy used in compound, what else can be used?
• Has to be set at the right level

Question 13

Name 2 Pros of a Maximum Price (Price Ceiling)

Answer 13

• Encouraging more consumption of a merit good
• Helps people get necessities

Question 14

Name 2 Cons of a Maximum Price (Price Ceiling)

Answer 14

• Creates a shortage due to excess demand
• No thought for people who cannot obtain this good
• Government failure
• Unintended consequences such as black markets
• Cost of enforcing the Maximum Price
• Cost to retain this excess
• Opportunity Costs

Question 15

What are some of the Evaluation points for a Maximum Price (Price Ceiling) ?

Answer 15

• Government Failure arguments
• Policy used in compound, what else can be used?
• Has to be set at the right level

Question 16

Name 2 Pros of Price Discrimination

Answer 16

• Greater profits made by the firm leads to greater dynamic efficiency and potential economies of scale
• Some consumers do benefit from price discrimination (2nd and 3rd)
• Firms can cross-subsidise loss-making goods or services that might have good qualities for society

Question 17

Name 2 Cons of Price Discrimination

Answer 17

• Allocative inefficiency by exploiting consumers- less societal welfare (1st and 3rd)
• Growing Income inequality if those being discriminated against are Low income for 1st and 3rd
• Anti-competitive pricing as in 3rd, lower prices for elastic markets can lead to monopoly power

Question 18

What are some of the Evaluation points for Price Discrimination?

Answer 18

• The costs MASSIVELY outweigh the benefits
• The type of market- AstraZeneca discriminate for the sake of equity in Africa (SR Vs LR)
• Firms need to be able to separate the market into groups, price-setting power and prevent resale
• Level of information available