Market Mechanism, Market Failure Snd Gov Interventio

Question 1

What is price mechanism

Answer 1

• is the interaction between supply and demand and determines the market price

Resources are allocated through the price mechanism in the free market economy

The economic problem is solved through this mechanism

Price moves resources to where they are demanded or where there is shortage and removes resources where there is surplus

Question 2

Price mechanism use 3 function to allocate resources

Answer 2

Rationing- prices change to balance supply and demand. Particularly when there’s excess supply or excess demand.
Limiting of goods and service that are in high demand or short supply
- when there is scarce resources = price increase due to the excess of demand . They increase in price= discourage demand and consequently rations resource

Incentive
- someone that motivated an agent in economy
- this encourage a change in behaviour in a consumer or a producer
Price offer both buyer and seller financial incentive
Supplier are encouraged to to expand production as higher price allow them to have increase profit. Lower prices on the other hand discourage more production as seller profit are reduced

Lower price give incentive for consumer to buy more whereas higher market price motivated people to consumer less or look for substitute

Price influence both buyers and sellers behaviour in this way, encouraging efficient resource allocation

Signaling
is where a change in price of a g/s thats show that supply or demand should be adjusted
Price acts as a signal new firms to enter the market as its profitable.
However high price signals consumer to reduce demand and therefore leave market

Question 3

Advantage and disadvantage of the price mechanism and of extending its use into new areas of activity

Answer 3

Advantages
Allows consumer to gain sovereignty in the market. They are able to choose what is bought and sold. They are acting in their own self interest

Generally the free market allows for efficient allocation of resource

Also price mechanism guides resource towards their most valuable use based on consumer preferences and market demand which also allow efficient resource allocation .
This can be due to the profit motive= drive producer to satisfy consumer demand whilst simultaneously maximizing profit.

Disadvantage
However they may be inequality in income and wealth with the price mechanism.
It does not consider what the distribution of income is . Those with money have buying power=. Able to purchase more goods/services whilst those without money are left out
Certain market like education and healthcare don’t always mix well with the price mechanism. As wealthier individuals have an advantage

Essentially the price mechanism and the free market ignore equality. To evaluate it can be argued that inequality exist may vary between capitalist society
Such as Covid 19 vaccine program, individual with the greatest need may have been the first to be offered vaccine around the globe

In free market there is under provision of public and merit good= pricing mechanism has trouble allocating resources when goods are non excludable and non rivalrous= leads to market failure.
This requires gov intervention

Question 4

Price mechanism analysis when there a shift in demand curve

Answer 4

Non price factors shift demand curve.
Shift at the initial price at P1. Supply remained at s1, whereas demand has shift and is now greater than supply= excess demand=disequilibrium= firms are going to be seeing large cues of people desperate to buy g/s.= prices rises. Excess demand puts upward pressure on prices= price rise from p1to p2

Higher prices signal the fact that there’s been excess demand for both consumers and producer.

Higher prices signal for more resources in this market

Higher prices incentivise firms to increase their output to make profit= as they can supply more at a higher price= this is shown by an expansion along the supply curve=This could be new firms entering market, this could be existing firms increasing output by investing in new capacity, or using up space capacity

Higher prices also ration scare resource by discouraging consumption= can show that by an contraction in the demand curve= end up and quantity Q2 which is at equilibrium= allocative efficiency

The re allocation of resource is now at a high quantity at higher prices

Can use gold as an example. Price is usually high as gold is big in demand and is very scarce

When oil price tripled in the 1970, this encouraged new countries to start producing oil as it was profitable for the UK to produce

Question 5

Price mechanism analysis when there’s a shift in supply curve

Answer 5

With the supply shift to the right that happen at P1, we get the supply at QS

The demand has remained at p1, supply is greater than demand= excess supply

With surplus= warehouse full of stock, physical stores will be full of stock on shelves, in restaurants table empty, kitchen full of ingredients

At this point prices naturally fall= excess supply surpluses put downward pressure on prices prom p1 to p2

The lower price first signal that threes been an excess supply for consumers and producers.

Also signal the need for fewer resources in the market

Lower prices incentives producers to reduce output by selling stock= to increase profit= can show that by a contraction along the supply curve= firms leaving market or existing market cutting capacity= reducing output

Lower price ration scarce resource by encouraging more demand = lead to and
expansion along the demand curve= lead to a new quantity Q2= equilibrium =
allocative efficiency = excess supply completely taken away

Question 6

What is a free market

Answer 6

A free market is a system of buying and selling goods and services that is not under the control of the government ·
- it’s pretty good at allocating our precious, scarce resource as fimrs are producing according to what consumer want and what they are willing to pay for the g and s
If there is big demand for something(excess demand). Then firm will react by producing more of it

That way the resource on our planet are being used by they are being allocated to people who want to use them and allocated to people who get a welfare benefits from the sources

Question 7

What is market failure

Answer 7

Occurs whenever the market leads to misallocation of resource

Misallocation of resource - when resource are not allocated to the best interest of society=bleeds to a net social welfare loss

Economic welfare and social welfare not maximized

• the market fails to account for the external cost and benefits- the free market only considers the buyer and seller

Question 8

Types of market failure
The free market does not take into account

Answer 8

• externalities- is the cost or benefit 3rd party receives from an economic transaction outside of market mechanism.
  There’s a spillover effect on production and consumption of goods/services
  Negative externalities- caused by consumption of demerits goods like cigs . It won’t be accounted for in the free market as consumer will ignore any impact of the 3rd party as it consume as they are utility maximizers= only consider their private benefit
  firm will ignore 3rd party impact when they produce as firms profit maximiser so the will consider their private benefits
  So both act on their self interest

positive externalities caused by consumption of merit good such as recycling scheme

• the under provision of public goods
  Public goods are non excludable and non rival and they are under provided in a free market due to the free rider problem
  When private firms dont want to supply certain goods they think won’t be profitable. A welfare benefit still exist for these products but firms won’t supply them so the product will not be made

Imperfect information- assumed that consumers and producers have perfect info when making decisions= however rarely the case. , imperfect info = misallocation of resources
- demerit and merit goods- don’t know how good or bad these service are= might make consumers make irrational decision

Monopolies -
Since consumers have very little choice where to buy goods offered by monopoly ,due to low competition =often exploit charging higher prices = lead to misallocation of resource= since consumers needs and wants are not fully met

Inequalities in distribution of income and wealth
Income refers to the flow of money, wealth refers to a stock of assets= leads to negative externalities such as social unrest
Income hasn’t been distributed equally- few people in the economy that are rich whereas millions of those who are breaking even and on poverty line

• in a market economy , an individual ability to consume good and service depends upon their income and wealth and inequitable distribution of income and wealth are likely to lead to misallocation of resources

Gov can use progressive tax and gov spending to reduce inequality
Progressive tax- take more income trom to ohh and less in poor

Gov spending- in welfare payment such as when unemployed receive job seeker allowance , providing support = inequality from riches to poorest can be reduced

Question 9

Public goods

Answer 9

Public goods - refers to commodity or service made available to all members of society - typically provided by government paid through tax
- they are non excludable( by consuming the goods, someone else not prevented from consuming it)
- they are non rival( benefit of others get from the good does not diminish if more people consume it
- non rejectable

They are missing from the free market but offer benefit to society such as street light, flood control system are public goods

Non excludable nature of public good gives rise to the free rider problem - people who do not pay for the good still receive benefit, the same way for people that pay
= reason why it’s under provided by private sector as it don’t make a profit since consumers don’t see the reason to pay for the goods

Government provide public good and they have to estimate what the social benefit of the public good is when deciding what output of the good to provide
They are funded using tax revenue , but the quantity provided will be less than socially optimum quantity

Question 10

What are private good

Answer 10

Private goods are rival and excludable.
So where consumption of food reduces amount available for consumption by others

For example, a chocolate bar can only be consumed by one consumer. Moreover, private property rights can be used to prevent others from consuming the good.

It’s scarce which cause competition for it
Less likely to have free rider problem

People have to pay good to enjoy its benefits

Question 11

What are quasi public good

Answer 11

Quasi (non-pure) public goods have characteristics of both public and private goods.
They are partially provided by the free market.
There’s a ability to stop non paying consumer from using it

Toll roads are quasi-public goods. While they are excludable (you must pay to use them), they are non-rivalrous because one person’s use does not significantly affect another’s ability to use the road.

Technological change can be significant. For example, television broadcasting is now excludable with subscriptions available to those willing and able to pay for them.

Question 12

What is the tragedy of commons
( public goods spec)

Answer 12

refers how individuals prioritise personal gain over the well-being of society.

• When resources are held in common, it means that no one owns the resource, but everyone can access it.

-For example, no one owns the air, but everyone can use it. This unlimited use leads to the negative externality of air pollution. This is a market failure that results from common access.

Question 13

Example of public good and quasi goods

Answer 13

Example of public good

street lamps- typically non excludable and non rival. Providing light at night cant stop anyone consuming the good
• Flood defenses- protecting the coastline against flooding provides benefit for the whole community

• National defense- consumed collectively so your not in rivalry with other people, you may nor pay or contribute to national defense

Quasi good

• Private parks- could be excluded from entering if you don’t pay, but your usage of the park doesn’t typically reduce the amount available to others
• Non renewable energy, eg, coal- typically non excludable but again is rival as its limited supply= there’s lots of people fighting for it.

There can be market provision of public goods- local communities raising money to pay for a local school, new garden

Alternatives: gov intervention = raise funds for tax to pay for the provision of public goods= ensures they not under provided

Question 14

Why do public good result in a market failure

Answer 14

If firms objective if profit maximization= a firm ideally wants their products to be excludable and rival so they can charge high price from it, only to those who benefit and therefore make a huge profit= public goods will not be provided by the free markets as firms cannot profit from them= can call this complete market failure as market doesn’t supply good at all

Question 15

What are merit good

Answer 15

A good that provided services and creates external benefits

Cause positive externalities
Also associated with info failure(asymmetric info) as consumers don’t realize long run benefits of consuming good or choosing to ignore the info
They are under provide in the free market such as education, healthcare

Question 16

Examples of merit goods

Answer 16

Education- some consumers don’t know the long term impact of it like higher incomes and better living standards in the future

= leads to irrational decision = will be under consuming

Healthcare

Fresh fruit

Vegetables

Question 17

What are demerit good

Answer 17

• a good where production or consumption has a negative impact on consumer
• caused negative externalities- associate with information failure since consumer unaware of long run implication of consuming the good

Usually over provided

Such as smoking , alcohol

Question 18

The over provision of demerit good and under provision of merit good may result from….

Answer 18

Imperfect info about long term implication of consuming gold

Such as education under provided in free market as the long term benefits not accounted for in society

Question 19

What is symmetric and and asymmetric info

Answer 19

Symmetric info means that consumers and producers have perfect market info to make their decision = leads to efficient allocation of resources

Asymmetric information leads to market failure. This is when there is unequal knowledge between consumers and producers.

Question 20

Examples of asymmetric info

Answer 20

For example, a car dealer might know about a fault with the car that the consumer is unaware of. This could lead to a misallocation of resources

. Another e.g.- labour markets: employee only got info about how they are as a worker, THE EMPLOYER does NOT have that info, wont get the perfect info= may make the irrational decision to employ the worker
= may not maximise their benefit

second hand car markets buyer is lacking information’s whereas seller has all the info about the state of the car= buyer may make an irrational decision to buy

Consumers can also know more information than the producer, such as when purchasing insurance policies.
E.g. the car owner know how much of a dangerous driver they are, but the insurance company don’t have that info= difficult to issue a price for on insurance for that individual car driver.
For an individual always an incentive to under report the level of risk to keep price of insurance low
= irrational decisions could be made as they may issue a price lower than what should be charged as not enough info shared between car driver and insurance company.
can lead to moral hazard- individual takes more risk as they are not going to bear the cost of those risk= not in the best interest of the insurance company

Question 21

What is imperfect info

Answer 21

where information is missing or not
presented clearly, so an informed decision cannot be made= overconsumption or under production taking place. E.g. consumption of merit goods and demerit goods

• With merit goods not enough info out there which tells the consumer how good consuming that product is for them= as a result its under consumed(= not utility maximising give e.g.)

• I the real world Some consumers don’t make rational utility maximising decisions. The notion of imperfect info can prevent consumers acting in a rational utility maximising way
• This leads to a misallocation of resources. Consumers might pay too much or too little, and firms might produce the incorrect amount. For example, monopolies might exploit the consumer by charging them more than they need to

Examples

Until 2019, Coca-Cola, the highest consumed soft drink in the USA, did not mention its sugar content publicly. Because the consumers were unaware of the high sugar content and the possible risks associated with the product, they consumed it disproportionately. This over-consumption has made the public overweight, which puts a significant strain on the healthcare system.

Another is moral hazards- when individuals alter their behavior during to certain guarantees
Framing issues

Question 22

How is asymmetric info linked with the principal agent problem

Answer 22

Asymmetric information can be linked with the principal-agent problem. This is when the agent makes decisions for the principal, but the agent is inclined to act in their o interests, rather than those of the principal. For example, shareholders and managers

Question 23

How can info be made widely available

Answer 23

Information could be made more widely available through advertising or government intervention. For example, the harmful effects of smoking could be made public through adverts and messages on cigarette boxes.

Question 24

Why the existence of monopoly and monopoly power can lead to market failure

Answer 24

The basic model of monopoly suggest that higher prices and profits and in efficacy result in misallocation of resources compared to the outcome in a competitive market

Monopolies could exploit the consumer by charging them higher prices. This means the good is under-consumed, so consumer needs and wants are not fully met. This loss of allocative efficiency is a form of market failure.

Monopolies have no incentive to become more efficient, because they have few or no competitors, so production costs are high. There is a loss of consumer surplus and a gain of producer surplus.

Question 25

Why the immobility of FOP can lead to market failure

Answer 25

The mobility of Labour is the ability of workers to change between jobs. Unemployment is evidence that labour markets do not work efficiently
.
• Frictional unemployment may exist whilst people move between jobs and search for new ones.

• Structural unemployment occurs when there is a decline in an industry. This can mean worker skills do not match the location and skills required for the job. This is more serious

The geographical immobility of the factors of production refers to the obstacles which prevent the factors of production moving between areas. For example, labour might find it hard to find work due to family and social ties older people more reluctant to move), the financial costs involved with moving( removal expenses or cost of selling house), imperfect market knowledge on work and the regional variations in house prices leads to shortages of affordable housing in many areas) and living costs across the UK high cost of renting), cultural and language barriers to living and working overseas.

The occupational immobility of the factors of production refers to the obstacles which prevent the factors of production changing their use.
For example, labour might find it difficult to change the occupation. This occurred in the UK with the collapse of the mining industry, when workers did not have transferable skills to find other work. The causes include insufficient education, training and skills.
(structural unemployment change)
Another e.g. is use of automation- robotics/ machinery replacing jobs

Question 26

What is competition authority

Answer 26

• Definitions; are government intervention that reduces monopoly power and introduces competition to reduce consumer exploitation, also insure public interest is being protected

• Aim: to prevent excessive pricing (in monopolist or oligopolist market), to promote competition, to ensure choice/ quality and standard, to ensure monopoly profit being made are being reinvested
into innovative new products, technology
- collusive behaviour

• Small and Medium Sized Enterprises (SMEs) are important for creating a competitive market. They create jobs, stimulate innovation and investment and promote a competitive environment. (advantages) There are 5.7 million SMEs in the UK

The CMA is the UK’s primary competition and consumer authority. It is an independent department with responsibility for carrying out investigations into mergers, markets and the regulated industries and enforcing competition and consumer law. From 1 April 2014 it took over the functions of the Competition Commission

What do the regulators do in their respective markets

Regulating cartels/collusion
Monitoring and regulating price
Regulators aim to ensure that companies do not exploit their monopoly power by charging excessive prices.
- The CMA must be notified of mergers and they can investigate if they think they might be against public interest

Investigate particular industries and see whether they are in the public interest

Companies that fail to meet specified service standards can be fined or have their franchise / license taken away.—the Royal Mail is still required by law to provide a uniform delivery service at least once a day to all postal addresses in the UK

Opening up markets: This might be achieved by forcing the dominant firm in the industry to allow others to use its infrastructure network

• Governments aim to improve access to finance and reduce barriers to entry, which will make it easier for smaller firms to enter the market.

Question 27

How can competition policies be achieved

Answer 27

protecting competitive markets

• Restricting mergers and prohibiting cartels

• Improving the way in which markets work e.g. providing greater information

• Creating fairness in markets for both firms and consumers so that firms don’t abuse their dominant market position but are able to make acceptable profits that will drive innovation and increases in productivity

• Increasing productive, allocative, static and dynamic efficiency

Question 28

Cost that lead to competition policy being unsuccessful

Answer 28

It might reduce creation destruction-where large firms are dynamicall efficient as they can provide huge investment in R&D leading to innovative product/production processes

Stop firms from gaining EOS which lower AC

Lead to government failure as authorities create inefficiency in market

Question 29

Benefits from successful competition policy

Answer 29

• Lower price: Increased competition= more number of firms leads to a shift of the supply curve to the right leading to a fall in market price

• Improved quality: In order to maintain a oustomer base within a competitive market firms will strive to provide better quality products and customer service or risk losing market share

• Increased choice: Competition creates an increased range of products which will lead to an improved allocation of resources as firms are more likely to produce products that a variety of customers will wish to buy

• Innovation: Both productive and allocative efficiency will occur as firms invest in R8D and continually look to improve production processes to lower costs over time and develop new products

• This will benefit society as a whole as these new products and processes lead to improvements e.g. technical change that can be used across markets

• Competitive advantage: Internal UK and EU competition will lead to leaner, more efficient firms that have a better understanding of the requirements of the consumer. This will help BU firms compete in a global market e.g. against US, Chinese and Indian firms

Schumpeter, an economist, proposed the idea of ‘creative destruction’. This is the idea that new entrepreneurs are innovative, which challenges existing firms.
The more productive firms then grow, whilst the least productive are forced to leave the market. This results in an expansion of the economy’s productive potential.

Question 30

What is public ownership

Answer 30

Is the provision of goods and services by government . In the Uk this takes many form including education , the health service and policing and the services such as public ownership

Nationalization. Occur when the government take a privately owned business into a public ownership

In the decades after WW11 a succession of local government nationalised (. Took public Owenership). A variety of UK industries

Another example was that the railway industry in UK was nationalized after 1945.
Railways were nationalised to help rebuild the network infrastructure and re-equip the rolling stock after the destructive effects of the Second World War.

By nationalizing an industry natural monopoly was created. This is because for example inefficient to have multiple sets of water pipes= therefore only one firm provides water

The stated aims were to protect nationally vital industries from the dangers of profit driven private enterprise and to be able to best allocate resource in national level

Much later, and following the financial crisis, several UK banks were nationalised or part-nationalised, including Northern Rock in 2008, and the Lloyds Banking Group and the Royal Bank of Scotland (RBS) in 2009.

Question 31

Argument for public ownership

Answer 31

• Greater productive efficiency through owning an entire industry leading to large scale economies, particularly in the case of natural monopolies
= productive efficiency gains= lower average cost= potential lower price to consumers

• Strategic control of important industries believed to be essential in maintaining the economy e.g. energy

• Economic welfare might be better catered for e.g. provision of loss making products for poorer people in society
  = this is due to gov intention to maximize social welfare= will consider the full social cos and social benefit when it comes to producing = minimizing over production and underproduction issue that might have had in the private sector

• Long-term strategy e.g. investment plans unhindered by the vagaries of the market as short-term profit to please shareholders is not seen as an objective

• Government provision of, and a co-ordinated approach to, infrastructure e.g. roads, rail and energy provides positive externalities to all firms in the economy

• Increased government revenues from firms with monopoly power

Question 32

Privatization

Answer 32

Is the transference of assets from the government to privately owned businesses
The UK has seen a range is of firms privatized since the 1970
For example British’s airways was privatized in the UK and now operates in the competitive market (1987)

Also royal mail was privatized in UK in 2015= done by allowing royal mail to float on the stock market. At the offer price, the gov owned 30 percent of the shares

Question 33

Agreement for and against privatization

Answer 33

Arguments for privatisation include:

• Greater productive efficiency as profit maximization objective leads firms to cut average costs

• Innovation is more likely as firms strive to increase profits and market share by meeting customer needs. This leads to dynamic efficiency

• Allocative efficiency occurs as market forces ensure that goods and services are produced to meet the needs of the consumer.= g/s are of a higher quality This leads to greater choice and lower prices as firms compete supernormal profits away due to competition

• Increased competition rather than government monopoly leads to greater economic efficiency

• Government revenue increases by selling off state assets and expenditure falls as they no longer incur costs for the industry

• however this is only a one off payment= unpredictable cash flow= miss out on recurring revenue= or may discourage the private sector to purchase it in the first place

Disadvantage
Privatisation leads to monopoly power as most firms privatised operate in markets with barriers to entry such as economies of large scale. This can be countered through regulation and deregulation.

• also when when large firms get privatized= may have no competition = a monopoly may be formed = productive inefficiency = firm not gonna operate in the minimum point in the a average cost curve= may become allocatively inefficient

= won’t produce g/s in the highest quality

Evaluation
- depends on the industry . If you ally it to industries such as healthcare or public transport = profit motive less important = won’t give the incentive to increase efficiency
- depends on the quality of regulation- may not make the privatized firm meet certain standards of service and keep price low

Question 34

What is deregulation

Answer 34

By deregulating or privatizing the public sector= firm can competed in a competitive market=. Help improve economic efficiency

Deregulation is the act of when government reduces how much an industry is regulated. enhances competition= lowers legal barriers to entry= incentivize firms to enter the market

Excessive regulation is also called ‘red tape
that a firm produces. E.g, environmental laws and taxes might result in firms only being able to produce a certain quantity before exceeding a pollution permit.
Excessive taxes, such as a high rate of corporation tax, might discourage firms earning above a certain level of profit, since they do not keep as much of it=might limit the size that a firm chooses, or is able to, grow to.

A good example of deregulation is mail delivery. For many years, the government-owned Royal Mail had a legal monopoly on delivering letters and parcels. The Royal Mail had a duty to deliver a letter anywhere in the UK, but competition was not allowed.
Firstly, competition was allowed in parcels, then in 2006, any licensed operator is allowed to deliver letters and parcels to business and residential customers

Question 35

Deregulation for and against

Answer 35

-
More choice= more firms are going to produce g/s that will satisfy the needs and wants of consumers= as a result striving for allocative efficiency = huge incentive for firms to produce where P= MC to make sure they satisfy and be ahead of consumers

Good chance of productive efficiency occurring = incentivize firms to to minimize cost and try to maximize profit= stay ahead of their competitors = try to produce and the minimum point on the AC curve

Increase in dynamic efficiency = as it’s competitive = some supernormal profit made.= can be reinvested again to stay ahead of competitors = over time with innovation= firms can reduce their cost, reduce their price, gain market share,

Less government intervention allow firms to produce the needs of the market

Disadvantage

Short-termism of firms

As well as the government being motivated by short-term pressures, this is something private firms may do as well. To please shareholders they may seek to increase short-term profits and avoid investing in long-term projects. For example, the UK is suffering from a lack of investment in new energy sources; the privatised companies are trying to make use of existing plants rather than invest in new ones.

Other market failure like externalities cannot be fixed with deregulation

Deregulation could also mean less safety and protection for consumers= large firms could abuse this power= formation of oligopolies and monopolies= could raise price, productive inefficiency and allocative inefficiency can well occur through deregulation
Seen with bus market deregulation, local monopolies have formed causing higher prices

Firms may prioritize profit above all other objective-. They may cut cost= decrease quality or safety of the product such as building a house= firm may decide to save on cost and use Lowe quality production methods

Loss of natural monopoly= increase cost= lower productive efficiency, can’t benefit EOS.
Also might see a wasteful duplication of resources so with natural monopoly makes sense for there to be one major firm dominating and providing all the resources whereas by deregulating market and allowing firm to duplicate these resource= opened up for waste= so wasteful duplication of resources = allocative inefficiency

Depends on
- shot run vs long run outcomes, if you see oligopolies and monopolies forming= chances are in long run contestability is going to fall
Market may be contestable in the short run
Failure of policy

Also depends on the height of other barriers to entry
Such as technical barriers to entry= may be very high= discontinue new firm entry in market = see a huge increase in competition

Also if there is oligopolies and monopolies= there needs to be strong government regulations.
privatized firm will need a regulator- likely the gov will have to organize a regulator to regulate the firm / industry= regulator ensure that the private firm do not operate against society interest
However regulations cost money

Question 36

Why would government want to transfer ownership of its firm to private sector

Answer 36

The government primary objective is to maximise the welfare of society

Publicly owned firms don’t make profit- no profit = no incentive
To create competition

Question 37

What are regulation

Answer 37

• rules/ laws enacted by the gov that must be followed by economic agent to encourage change in behaviour

Can use it when there’s over production/ overconsumption or underproduction/ underconsumption
Such as age limits on cigs, alcohol
Compulsory regulation such as graphic imagery on cigs packets -
vaccinations , compulsory recycling schemes

They need to be controlled- strong enforcement unless no one will follow it= no incentive since it wouldn’t be checked
There needs to be effective punishment such as fines, bad publicity, jail time
HOWEVER might pass on higher cost to consumers from the fines

For example. Be in education till 18(. Minimum school leaving age)= positive externalities in terms of higher skilled workforce
- legal age for smoking is 18
Collusion and cartel are banned by competition policy
Prohibition on certain classes of drugs- cocaine, heroin, cannabi

Question 38

Arguments for and against regulation

Answer 38

Advantages

Gives incentive to change behaviour - to consume more or produce more or less.=. To more quantity to the socially optimal level= A legal ban sends a clear signal that it is wrong (e.g. drinking alcohol in city centre)

can give incentive for firms to strive for productive efficiency through reduce cost

Solves issues in the free market = allocatively efficiently and welfare gains

Protecting consumer against the abuse of monopoly power that would lead to higher price, supernormal profit and allocatively inefficiency

Ensure quality and choice are maintained ion monopolistic markets

BUT
- regulation costly= administrative cost due to the enforcement either regulation = it needs policing = needs monitoring to see if firms are abiding by the rules
if cost can’t be afford = regulation will be very poor

If the command is set at a strict level= many unintended consequences =. Increase cost significantly for firms = reduce profitability = firms country to operate elsewhere where not too strict
Another intended consequence= reduce production =decrease in unemployment

If regulation too strict on consumers- may look for alternative supply and go to the black market=. Loss of tax revenue for government= also policing= increase in cost

If regulation not set too strictly =. Less incentive to change behaviour

Question 39

How can regulation be set to correct market failures

Answer 39

• in case of demerit good= banning/ limiting sales

-in case of monopolies- setting price caps to limit maximum price

Question 40

Disadvantage of nationalization

Answer 40

Risk of diseconomies of scale (draw the diagram), if public sector is dominating in industry- problems of co-ordination, communication, motivation could take place-increase in average cost= loss of productive efficiency= lead to higher prices in the end for consumers

• Lack of profit motive= lack of supernormal profit being made in nationalisation industry compared to privatisation industry= dynamic inefficiency= don’t see the technology gains, the innovation benefits, R and D, as less likely to reinvest.
  Privatisation more likely to reinvest

Highly expensive and a burden on the tax payer. Maintaining state companies, paying wages, buying assets is expensive.= increase budget deficit= national debt.
If gov do nationalised industries= opportunity cost= could be better benefit in other areas or better return

Evaluation
1. Even if nationalization is expensive it may be worth it at the end result =society get better delivery of key public services than a private sector

2. Don’t need full nationalization if there’s strong regulation of private sector = better
3. Consider the objective of private sector firms- not all firms are profit maximizing= they may strive for allocatively efficiency or concerned of corporate social responsibility= good for society = not always guaranteed private sector is going to profit maximise

Question 41

Government intervention

Answer 41

• gov intervene in market to correct market failure
  For example provide education which free market would under provide
  Or maximize positive externalities or reduce supply of demerits goods

Question 42

Indirect tax

Answer 42

• tax on expenditure to increase the production cost for producer so they can supply less
  Increased market price demand contracts
  Can be use to discourage production or consumption of a demerit good that harms society

Also used to solve market failure such as cigarette duty , alcohol duty, fuel duty, sugar tax

There are two types of indirect taxes: o Ad valorem taxes are percentages, such as VAT, which adds 20% of the unit price. This is the main indirect tax in the UK

• a specific tax- a set of tax per unit such s wine duty

Impacts
Price increase, quantity decreases=reduce the quantity of demerit goods

• Decrease in producer revenue decrease in producer surplus

Consumer will not like it: it raise price= lowers consumer surplus, lower quantity and choice. Indirect tax highly regressive- take a larger proportion of income on lower income households than higher income households. Also if demand inclastic= impact greater= higher tax burden for consumers

Workers- potentially lose their jobs= as labor is derived demand= with quantity falling less need for workers to produced

Government going to like indirect taxes= raise revenue. HOWEVER they wont like the fact theren uniteded consequences e.g, the harm on consumers, the regressive nature of indirect tax, harm to producers as they may shut down or leave the country= less revenue

Question 43

Subsidy

Answer 43

Money grant to firms by the gov encourage an increase in production of a good that are beneficial to the whole of society

• such as healthcare vaccination, education( if the long term structurally unemployed workers gain useful training and education= enables them to find work.= gov receives more tax revenue, pays less unemployment benefits

, public transport like trains , buses, recycling scheme= yield lodge externalities
Cause: to solve market failure and to increase affordability especially on necessity I g/s as it reduce price in the market = very helpful for lower income household to access the market

• also encourage the consumption of merit goods, external benefit is internalized
• as it reduce COP of firms = shift to the right= price decrease , quantity increase = however possibility of excess demand

If subsidizing on public transport= encourage people to drive less and reduce their negative externalities = in long term, subsidies of a good will help change preferences= encourage firms to develop more positive externalities

Long run concerns for consumers- may be cuts to other areas of gov spending in the economy which could hurt consumers

Increase in producer revenue/ surplus. Greater employment due to higher quantity as labor is a derived demand so its good for workers

Gov: how expensive the subsidy is, opportunity cost, also be concerned on how the subsidy is being used= are producers taking advantage of subsidy using other things for the subsidy like paying debt or paying higher wages to staff)

• Also in long run, producer may become dependent on subsidy= become inefficient allowing other cost of production to rise knowing its free money

Question 44

Price control minimum price

Answer 44

Where consumption or production of a good is to be discouraged = ensures good never falls below price
- such as national minimum wage
- Scotland imposed a minimum price on ALcohol
Reason imposed is that in a free market at p1,Q1 there will be an underproduction and overproduction of alcoholic drink

-. By imposing a minimum price above the equilibrium = contract demand, consumption is discourage,
Quantity in the market will fall from q1 to q starting

Lead to the socially optimum level of output= will get to allocative efficiency= welfare can be maximized

• reduce negative externalities as consumption will fall, consumers will demand less
• will yield positive externality of decent wages = which will increase living if standard of the poorest= provide an incentive for people to work

BUT
If its price inelastic = demand will be proportionally less than increase in price= might not see a fall in quantity enough to solve market failure

• individual will always find alternative supplies in the black market= dangerous = gov failure
  Tax revenue can be loss if individual buying it from illegal sources

Set at the right level?- if it’s set really high = impact on firms who may leave = shut down(. Uninterested consequence)
BUT if g/s price inelastic= still see an increase in revenue

Question 45

Maximum price ( price control)

Answer 45

Gov might set maximum price where consumption or production of food is to be encouraged.
Is so good does not become for too expensive to produce or consume example more consumption on rent accommodation

Maximum price have to be set below free market price , otherwise inefficient

• it promote equity
• prevent monopolies exploiting consumers= welfare gain.l for consumers keeping price low=. Increase efficiency = incentive to keep cost low to maintain profit
• price reduction = there’s an extension in demand= more consumption and equity as a result
• solve income inequality where price exclusion shouldn’t exist

BUT
Shortage will be created = there’s extension of demand but contraction of supply= the gov created excess demand = inefficiency in markets, many individuals won’t get_

Since there’s excess demand = likely to go to the black market= dangerous for consumers as they might be exploited like landlords

With price low/= reduce firm profit= not achieving profit max = less investment in long run
If price lower, quality offered might be low aswell.

Setting the right level— is it set too low= massive excess= not see the promotion of greater equity.

Question 46

State provision

Answer 46

• is the direct provision of g/s by the gov free at the point of consumption
  Gov is taking over the market completely, allocating all resource towards a given. G/s
• for example used when there’s inequity in merit goods, can be argued that no price should be charged to exclude consumers from that market
  Healthcare and education— there’s underconsumption
• it solve public good market failure left to the free market

In UK we have state provided healthcare such as NHS, state schools

• therefore solved the underconsumption / production of merit good= solve the inequality issue
  Also solve missing market (public goods)= get allocative efficient as we reach the socially optimum level in theory

BUT
- creates excess demand- always occur whenever something is provided free at the point of consumption
To solve this gov can ration the excess demand by depending on severity of condition= determines treatment= not a perfect solution as it normative = not efficient

Excess demand = long waiting question
Consumers may not pay a price but paying poor quality provision in school or

ARGUE
There’s rate of private sector those who can afford it= an alternative option = alleviate pressure on state provided g/s

• expensive= as gov taking over entire market= huge sums going into state provision= cut in other areas of gov spending= opportunity cost

Gov don’t have perfect info = quantity may not be at _ could be higher= gov failure argument

Question 47

Property rights

Answer 47

• when it comes to common access resources= biggest issue is that there’s no ownership such as forest sea, air

It’s an very producer self interest or over exploit these natural resource= ultimately depleting these resources = not socially desirable
Can be solved through property rights such as producer owned part of the forest and wants to cut trees for paper
The individual now has an incentive to not over extract these resources= not to cut down many trees

WHY
- if producer did= impact will be the individual producer= lost income in future = only they will suffer= externality will be internalized
So incentive so for producer to look after their land

If property right well issued= we get quantity that will end up at the socially optimum level= no depletion on these natural resources such as mass deforestation = allocative efficiency = welfare maximization

BUT
Property right can’t be efficiently distributed such as can’t get PR for sea air = problem
Enforcement costly= gov may not afford to police it= massive trespassing

Equity- who gets the right- they have significant power( foreigners that live in land)

Question 48

Information provision

Answer 48

Gov can fund info provision through advertising/ education to encourage or discourage consumption
Such as billboard , newspaper , radio
Schools - Gov funded changes to school curriculum to make kids more aware how good/ bad consuming certain food is

Or adult seminars/ clinics

Or another e.g. gov might make it illegal for second hand car dealer not to reveal entire history of a car= so consumers know exactly what they buying

• helps solve merit good/ demerit good market failure as there’s imperfect

This policy much more market friendly= much consumers hand = not very interventionist
- diagram analysis

• both enables consumers to make rational decisions as they know what’s true private benefit when it comes to consuming merit good or demerit good= they have the info= solve issue of over or under production or consumption= hit allocative efficiency = maximise welfare

BUT
- expensive as its gov funded
No guarantee of success= no guarantee that info provision actually going to encourage more consumption or less for demerit goods
Especially if policy is a poor quality not targeting right consumers or ignoring it

It’s more likely to work in long run= takes a while for info to be absorbed by consumers for them to change their consumption habits

• market friendly

Question 49

Government failure

Answer 49

Gov failure occurs when gov intervention in the economy causes inefficient allocation of resources= decline in economic welfare

They fail to intervene the market which result in net welfare loss

It’s Assumed that Gov are experts when it comes to making policy decisions
But as externalities can’t have an accurate value= might get policies too strict or too laxed= policy ineffective with significant cost

Question 50

Causes of government failure

Answer 50

Excessive administrative cost
The social benefit of a policy might not be worth the financial cost of administrative policy.
Might cost more than the gov anticipated
Gov has to consider whether policy is good value for money
1- regulation- significant admin and enforcement cost= if gov can enforce regulations = cost of policy significantly outweigh benefit.= people know that they can go against regulation, not be caught
2subsidies
.3 state pension
4… price control

Unintended consequences
- unexpected events occur due to gov intervention
Reason can be due to conflict long objective policies , administrative cost
1. Black markets( taxation, regulation , minimum price)
2. Impact on poor ( minimum price)
3 impact on firm of over strict regulation/ taxation— shut down, relocate = lead to unemployment firms becoming dependent on subsidies
4. Also unintended of excess demand from state provision

Regulatory capture
This is when regulators start acting in their interest of the company due to impartial info, rather than in consumers interest
Their problem of asymmetric info can make it hard to determine what level a price cap should be imposed at

Without sufficient info , gov could make poor decisions and it could lead to waste of scarce resource
OR maybe they are in close contact or regulators used to work in industry before= know the CEOS and managers= lead to ceos influencing regulator to reduce extent of regulation

Info gaps
— some policies might be decided without perfect info= might be due to inaccurate due to port research or inability to predict future=might require a full cost benefit analysis = could be time consuming and expensive
Gov Housing policies have failed several time in the past

Distortion of price signals
- gov subsidies could distort price signals by distorted market equilibrium
For example gov might end up subsidizing an industry which is failing or has few prospects
=also created market that would survive without gov support
= this distorts free market working of market = crested district prices leading to gov creating inefficient allocation of resource rather then correcting them

Question 51

Complete market failure

Answer 51

When a market is completely missing