Market faliure Flashcards
Indirect tax
A tax levied on expenditure
Direct tax
Tax levied on income
Incidence of tax
The way in which tax is spread between buyers and sellers
Specific tax
A tax of fixed amount on purchases of a commodity
Ad valorem tax
A tax levied on a commodity as a percentage of the selling price
Excess burden of sales tax
The loss to society following the imposition of a sales tax
Polluter pays principle
The idea that a firm causing damage to society should be forced to pay for that damage
Externality
A cost/benefit to a 3rd party
Hypothecation of tax
Spending tax revenue in the area it was generated
What is the effect of a specific tax
It reduces supply by increasing the producers costs
If a good has an inelastic PED what effects would imposition of a sales tax have
Higher revenue for government
Smaller fall in consumption
What factors affect the effectiveness of a sales tax on reducing externalities
The size of the tax
The elasticity of the good/service
Advantages of using tax to correct market failure
Market based solution
Raises revenue for government
Disadvantages of using tax to correct market failure
Difficult to measure externalities
Indirect taxed are regressive
Some taxes may be difficult to collect
Regressive
Has a larger effect on people with lower incomes
What is the effect of a subsidy
Shifts supply to the right
Why may a subsidy be better than taxation as a method of correcting market failure
Encourages consumption of merit goods instead of discouraging consumption of demerit goods
Taxes can be used to fund the subsidy
Why may a subsidy be worse than taxations
Costs money
Government expenditure
Where the government provides goods instead of a private firm
Why may state provision compare favourably to subsidy
Subsidy cannot provide public goods
State provision ensures fairer distribution of wealth
Why may state provision compare unfavourably to subsidy
State provision is more expensive
The lack of freedom in the market may stifle innovation
Advantages of state provision
Reduces inequality - All citizens have the same access
Supports macroeconomic objectives
Disadvantages of state provision
Expensive for government
Non-market based solution
Encourages dependence on government
Price control
A legal minimum or maximum price
Why may setting a maximum price be worse than using a subsidy
Maximum prices fail to increase consumption
Why may using taxation be better than setting a minimum price
Taxation raises revenue
Advantages of maximum prices
They are cheap
Reduces a monopolies purchasing power
Disadvantages of setting a maximum price
Supply is decreased because there is less profit
Will often lead to shortages
Black markets may emerge
Advantages of setting a minimum price
Encourages investment
Can cause stockpiles to build up
Disadvantages of setting a minimum price
Lowers utility
High opportunity cost
Allocative inefficiency
Disadvantages of setting a minimum price
Lowers utility
High opportunity cost
Allocative inefficiency
Merger
2 or more firms joining to form a new firm
What is a cartel
An agreement between firms on price or output with the goal of maximising profit
What is competition policy
Used to protect consumers and firms from being exploited by monopolies
Advantages of competition policy
Cheap
The threat of enforcement is often enough to correct the market faliure
Disadvantages of competition policy
The size of the fine may be unclear
The CMA may become too close to firms
Buffer stock
A scheme intended to stabilise the price of a commodity by buying supply when it is cheap and selling when it is high
Advantages of buffer stock
Market based solution
May be self funding
Disadvantages of buffer stock
May be expensive if storage is required for too long
Only works with commodities that can be stored for a long time
Why may a buffer stock be used instead of a subsidy
Buffer stocks are self-funding
Means that the market is not reliant on government intervention
Why may a subsidy be better than a buffer stock
The initial cost of a buffer stock may be too high
In buy years the process of buying buffer stock increases the price for normal customers
Legislation
Laws created by governmnet to enfoce regulations
Prohibition
An attempt to prevent the consumption of a demerit good by making it illegal
Advantages of regulation
Cheap because the infrastructure already exists for enforcing them and because the threat of enforcement is often enough
Disadvantages of regulation
Difficult to set the correct strength
They increase firms costs
May require international agreement
Why may regulation be used instead of taxation
If the goal is zero consumption taxation is pointless
Tax will not change behaviour where price is not a factor
Why may taxation be used instead of regulation
Taxes raise revenue
The cost to society of regulations are harder to predict
Information provision
When the government educates the public to help consumers make better choices
What is a pollution permit system
A system for controlling pollution based on allowing firms to buy permits that allows them to pollute
Advantages of using a pollution permit system
Creates incentives using a market based solution
The total level of pollution is limited as there can only be so many permits
Disadvantages of a pollution permit system
Must be enforced
Can be complex to set up and run
Why may a pollution permit system be better than taxation
Reduces the cost to society for reducing pollution
Firms know how to cut pollution better than government does
Why may a tax be better than a pollution permit system
The correct number of permits may be difficult to measure
Contracting out
A situation in which the public sector pays a private firm to fulfill their objectives
Competitive tendering
A process by which the private sector bid for a contract to provide a public service
public-private partnership
an arrangement by which a government service or private business is funded and operated by a combination of partnership between the public and private sector
Private finance initiative
A funding arrangement by which the private sector runs a public asset in return for payment from government
What is market failure
When the competitive outcome produced by the free market is not the best outcome for society
What are the 4 types of externality
Positive/negative externality of production
Positive/negative externality of consumption
What is allocative efficiency
Free market equilibrium
What are the 4 types of information failure
Asymmetric information - when 1 party has more information than the other
Moral hazard - when a party acts in bad faith because they know someone else will bear the consequences
Merit goods
Demerit goods
What are the 4 features of public goods
non-excludable
non-rivalrous
No marginal cost of production
non - rejectable
What does non-excludable mean in relation to public goods
If one person consumes the good that makes it impossible to prevent other from consuming it
What does non-rivalrous mean in relation to public goods
Consumption of the good by one person doesn’t reduce the amount available for others
What is non-rejectability in relation to public goods
Once the good has been provided then you cannot avoid consuming it e.g. the military
What is a quasi-public good
A good that has some of the traits of public goods but not others
What is a free rider
Someone who benefits from a good/service but doesnt pay for it
What are merit goods
Goods that are under consumed because people dont understand the benefits that come with them
WHat are demerit goods
Goods that are overconsumed because people dont understand the dangers that come with consuming them
