MICRO - 7. government intervention ✅ Flashcards
what are the forms of government intervention
- indirect taxation
- subsidies
- regulation/law
- price controls/manipulation
- information provision
- state provision
- pollution permits
- establishing property rights
total welfare increased if any costs incurred in intervention are less than benefits gained
how can market failure be approached
market self correcting itself
government intervenes which can lead to government failure
results in equitable and efficient market
pro free market economy views vs interventionist
- unregulated markets work well should be left to market forces vs intervention makes markets work better
- market mechanism achieves more optimal outcome vs markets are uncompetitive and prone to market failure
how can indirect taxation be manipulated
- higher production costs can be transferred to consumer, manipulates demand by affecting price
- increased production costs —> internalises externalities (polluter pays) —> saves overconsumption/production —> promotes allocative efficiency whilst generating gov revenue
why might indirect tax not always work
- price inelastic demand not suitable as responsiveness needed
- needs to be set at right level or political opposition may occur and unknown impacts could be incurred
- regressive as tax takes greater proportion of low income than of high income
- black markets could arise if price becomes too high
- increased costs causing inflation
what is the purpose of subsidies - how does it go about solving market failure
provided to producers to:
- reduce costs
- increase supply
- reduce price
- increase demand
what do subsidies do to correct market failure
correct market failure by:
- increasing merit goods output
- reducing inequalities
- improving factor mobility
- increasing market competition
- tackling information failure
how do subsidies solve market failure
lower production costs —> lowered price and increased quantity —> solves underconsumption/production —> allocative efficiency and welfare gain
how do subsidies influence costs
- subsidies = very costly
- opportunity cost exists if this is best use of public money could it be more productively spent as subsidy goes to every producer in industry
what problems are there with choosing the correct subsidy level
- subsidy set at right value, cant assume gov know PE value and over/under subsidy likely and market failure unsolved
- under subsidise = ideal quantity not reached and MPC in middle
- over subsidise = cost element becomes bigger and government failure occurs as a result of asymmetric information (info problem)
how can giving a subsidy to a firm create problems
- firms abuse power of subsidy and lose incentives as they rely on it so government failure as costs involved = significant benefits lost
- long run dependency for firms can allow costs to destabilise
- difficult to remove
how does elasticity influence the success of a subsidy
- for a subsidy to be successful = price elastic demand
- greater quantity in market to solve failure
- question effectiveness of subsidy with price inelastic demand
examples of subsidies to producers
- job retention scheme
- government grants for businesses with youth unemployed/long term job losses
- state aid for loss making businesses
- low cost affordable housing subsidies to construction companies
- export subsidies for producers
examples of subsidies to consumers
- people buying electric vehicles
- food and energy subsidies
- boiler scrappage schemes
- free tv licenses
- tampons and sanitary products
- subsidies for childcare tax free
what are benefits of subsidies on consumers
- helping with food and childcare = improved nutrition = labour productivity increased and long term burden on healthcare decreased
- encourages output and investment in fledging sectors eg life sciences, renewable energy
- protects jobs in loss making industries by recession and economic shocks
- improves housing and transport affordability to improve geographical mobility of labour
- reduce training cost and employing workers
- achieve more equitable distribution of income
what are other downsides of subsidies to consumers
- distorts market prices - misallocation of resources
- tax payers may pay and receive no benefit
- can conflict with other government objectives (gov impact)
what is government failure
intervention in market = net loss of economic welfare rather than gain
total social cost > total social benefits
what can cause government failure
- distortion of price signals
- unintended consequences
- excessive admin costs
- info gaps
- conflicting objectives
- politicians maximising own utility
what is included with distortion of price signals
- farming tariffs on imports to support domestic agriculture
- implementing/increasing min wage
- high unemployment benefits
what are unintended consequences
- good intentions having other consequences
- in gov intervention in markets usually at least one unintended consequences as economics is a social science and accurate prediction of reactions don’t exist
how does excessive admin costs = gov failure
cost of correcting market failure > welfare benefit from correction
how do info gaps = gov failure
government may make wrong policy response to problem as possess incomplete/misleading info
reasons for gov intervention
to correct market failure
to improve efficiency/equity
how can we measure effectiveness of intervention
- efficiency (better use of scarce resources?)
- effectiveness (meeting objectives?)
- equity effects (is it fair?)
- sustainability (how long will it last? long term impacts?)
- law of unintended consequences
what is regulation
rule/law imposed by gov must be followed by economic agents to encourage change in behaviour
it is a non market approach using COMMAND and CONTROL
what is command and control
COMMAND:
- bans
- limits (time)
- caps
- compulsory
- innovative regulations
CONTROL:
- enforcement
- punishment as people wont follow command without
no control = no success
what is the importance of regulation in solving market failure
- incentive to change behaviour (consume/produce less/more)
- moves quantity to social optimum and solves free market issues without working through it to gain allocative efficiency and welfare gain
what are problems with regulation
1) COST (admin costs to enforce, if cost cant be afforded regulation becomes pointless)
2) RIGHT REGULATION (too strict = unintended consequences and then more policing and more tax necessary = gov failure and firms may find way to cheat regulation)
3) BLACK MARKET (chances of alternative supply)
4) EQUITY (unfair on some firms if harder to change eg reduce pollution)
how can regulation influence government failure
risk of gov failure extremely high with regulation
what are price controls and manipulation
to combat free market prices which are;
- too high (merit goods)
- too low (demerit goods)
- too unstable (petrol)
MIN PRICE = price floor
MAX PRICE = price ceiling
how does market mechanism influence price
market mechanism establishes prices for goods/services in private sector
price may lead to inefficient/inequitable allocation of resources and gov may intervene to influence price
how are minimum prices used
- used to discourage consumption of demerit goods (negative externalities of consumption)
- to discourage consumption to quantity falls to socially optimum level and externalities internalised
- allocative efficiency and welfare maximised
what are problems of minimum price control to solve low prices of demerit goods
- PRICE INELASTIC DEMAND (demand not falling enough to solve failure)
- REGRESSIVE (widening income equality disparities)
- BLACK MARKETS (alternative supply, not solving market failure and tax lost = gov failure)
- SET AT RIGHT LEVEL (unintended consequences if price is too high so externalities not internalised, firms affected and unemployment can rise)
eval for inelastic demand in min price
if demand is price inelastic producers see revenue increase and dont suffer
how are maximum prices used
- price of market too high, below equilibrium
- encourages equity with more consumption of essential goods/services
- lower prices, demand inequality
- reduce inequalities by increasing spending power of poor
what is the main problem caused by maximum price
shortage of goods as contraction of supply = excess demand
what are other problems of maximum price
- BLACK MARKET (consequence of shortage, gov failure)
- ENFORCEMENT (contraction of supply is bad as likely to see more luxury goods driving out low income. low price = low quality, price below equilibrium
- SET AT RIGHT LEVEL (too low = excess demand, too high = no promotion of equity)
- COST (increase supply to reach equilibrium and big opportunity cost so gov failure. costs to repair problems = gov failure)
how does information provision solve market failure
- used to correct information failure (asymmetric info) with demerit goods
- informs about social/private costs
what is state provision
(direct provision) when nationalised industry (gov) = main provider of all resources for market as gov thinks free market wont succeed it does it itself
used for public/merit good failure
what is state provision used to do and how
- to encourage consumption of merit goods
- ensure public goods provided
through:
- direct provision (free at point of consumption)
- subsidised provision (make it cheaper but not free)
what are benefits of state provision
- resource allocation improves (towards social optimum)
- no price exclusion, free at point of consumption
- all social benefits likely to be considered
what are problems with state provision
- opportunity cost eg healthcare
- state run organisations tend to be wasteful (inefficient production and wrong mix of goods produced, no signalling function of price)
- ignores private sector
what does state provision depend on
- depends on how to ration excess demand as if not done correctly effect of state provision limited
- level of quantity if gov knows social optimum
what is a pollution permit
- allows owner legal right to emit specific level of pollution
- tackles pollution market failure and negative externalities
- gov sets level of pollution allowed and permits issued to firms to match this level
- if company doesn’t use full permit it can sell the rest to other firms
what is effect of selling pollution permits
creates a market for permits with price set by demand and supply
what are the aims of pollution permits
- provides market incentives for firms to reduce pollution and external costs
- reduce output to more socially optimum level
- make price of permit close to social marginal cost
- way for gov to raise revenue
what are the advantages of pollution permits
- incentive to decrease pollution as profits can be made from selling permits
-reduces level of pollution to social optimum increased welfare and allocative efficiency increased - market based solution and efficient and equitable for firms
problems with pollution permits
- deciding level of pollution allowed?
- high admin costs and difficult to enforce
- fines not strict enough
- geographical distribution
- need for international cooperation
what do pollution permits depend on
- level of information
- no of firms able to reduce pollution
what can property rights be used for
to solve tragedy of the commons market failure by using entitlement to use/sell a property plus legal rights others dont have
how do property rights help market failure
- incentive not to exploit common access resources
- negative externalities internalised
- if enforced will reduce quantity to socially optimum level
what are cons of property rights
- can they be efficiently distributed
- enforcement needed creates costs
- equity - who gets the rights can this be enforced
