Micro Government Intervention

Question 1

ad valorem tax

Answer 1

a tax on
expenditure imposed
as a percentage of the
selling price

Question 2

polluter pays principle

Answer 2

an argument that a
firm causing pollution
should be charged the
full external cost that
they inflict on society; link this to any measures that impose a cost equal to externality on firms, e.g. taxes, regulation

Question 3

when should authorities regulate monopolies?

Answer 3

1. stop antitrust and cartel behaviour
2. highly concentrated markets
3. merger/acquisition activity

Question 4

aim of intervention in monopoly markets

Answer 4

1. control prices - shouldn’t be set excessively above MC
2. maintain quantity and quality of provision
3. promote competition
4. regulate natural monopolies
5. promote tech advancement

Question 5

types of monopoly regulation

Answer 5

1. price - RPI-X (RPI and RPI+/-K)
2. Quality control - performance targets
3. windfall taxes on SNP
4. M/A policy - block or under conditions
5. competition policy - privatisation and deregulation

Question 6

how does RPI regulation work?

Answer 6

cap price increases by the retail price index inflation rate, which will allow firms to cover their costs and still make profit if they can make cost savings

Question 7

how does RPI-X regulation work?

Answer 7

RPI percentage minus X%, where X is the excepected efficiency savings that regulators thing firms can make

the difference is the amount that firms can increase prices by, and this will force efficiency savings to be made

regulators can be more harsh by setting a high value of X

Question 8

how does RPI +/-K regulation work

Answer 8

if K is positive, then firms can increase prices by RPI+K to fund capital investments while still protecting consumer from excessive prices

aim is to faciliatate improvements in tech and product quality

Question 9

analyse the pros of pricing regulation in general

Answer 9

it encourages firms to find efficiency savings, because they will want to cut costs as much as possible to maximise their profit at the capped price increase

will also protect consumer welfare especially low-income

Question 10

problems with price regulation

Answer 10

1. regulators may set wrong level of X and K due to imperfect info (firms conceal to soften blow). Too high means shut down and unemployment, too low means P remains > MC and lower CS and inequality
2. enforcement is costly - opportunity cost
3. regulatory capture - beneifts firms and not society, leading to govt. failure

Question 11

how does quality control regulation work?

Answer 11

set performance targets and then fine firms if they fail to meet them

e.g. monopoly train providers for having more than the target no. of delays each day; time target for ambulance services to reach patients

this increases both the quantity and quality of services

Question 12

problems with performance targets

Answer 12

1. quantity over quality may be encouraged - not in interests of society
2. firms finding loopholes that increase inefficiency - e.g. to avoid fines for delays, train companies may lengthen journey times more than required to compensate for potential delays, defeats purpose of policy

Question 13

how does profit control regulation work?

Answer 13

set a max level of profit that firms are allowed to make to equalise that of a competitive firm with the same costs and revenues. Will cover operating costs and provide a return on capital employed

forces firms to reduce prices since excessive profits will either be taxed or regulators will enforce harsher price cuts

Question 14

problems with profit control

Answer 14

1. info failure - firms may over report the true level of costs to increase permitted profits
2. promotes incentive for firms to not control costs since these will always be covered by the maximum level of profit imposed - promotes ineffiency and wastefulness
3. incentive to over employ capital even if not a worthwhile investment as this will increase value of CE and the permitted level of profit - wasteful and inefficient

Question 15

how do windfall taxes on monopoly profits work?

Answer 15

windfall tax imposed on SNP to lower amount of profit made. Will incentivise firms to reduce prices to reduce amount of taxable profits

tax collected can be used to enforce other forms of monopoly regulation or fund essential public services

Question 16

problems with windfall taxes

Answer 16

1. will increase MC for firms, resulting in even higher prices and lower quantities in order to cover costs and survive - worsens consumer welfare, defeats purpose of policy
2. promotes tax evasion/avoidance as firms find loopholes to avoid paying full tax, or under=report profits made - high prices, less tax revenue
3. could reduce reinvestment and dynamic efficiency gains, reducing consumer benefit from better tech, quality and innovation and possibly lower prices
4. could reduce incentive to enterprise and lead to brain drain

Question 17

how does M/A policy work?

Answer 17

in the UK, if a M/A will result in market share of more than 25%, then authorities will either BLOCK it or ALLOW IT WITH CONDITIONS like forced selling of stores to rival to promote competition in highly-concentrated markets

Question 18

problem with M/A policy

Answer 18

May be a normative judegement about whether it should be blocked or not - if the M/A is blocked, then govt. might limit EOS gains, pooling R&D resources for DE gains

Question 19

overall monopoly regulation eval

Answer 19

1. info failure leading to ineffective regulation and unintended consequences
2. cost of regulation - govt failure
3. regulatory capture
4. blocking advantages of monopoly - DE, EOS, cross subsidisation
5. not efficient to liberalise markets with natural monopolies - EOS, wasteful duplication
6. policies that reduce prices or impose strict quality standards may actually be BTE and restrict competition - unintended consequence!

Question 20

best policy to useto regulate monopoly depends on…

Answer 20

the type of market and the exact causes of the inefficiency

if natural monopoly, then price/quality regulation better than liberalising market

if state owned monopoly, problem may not be high prices but rather inefficiency so quality targets better

however, must question need for policy in first place - if inefficieny is not extensive, then higher risk of govt failure

Question 21

whether or not the govt should intervene to regulate monopolies depends on…

Answer 21

the contestability of the market - if large monopoly power but reasonably low BTE, then only limited intervention needed e.g. price caps

this is because 1) unnecessary policy may actually INCREASE BTE and lower contestability in LR, and 2) cost of intervention very high relative benefit to be gained in this situation, so risk of govt failure too high

Question 22

explain how regulation is used to solve market failure

Answer 22

• is a non-market based command-and-control approach
• rules set to increase/decrease C/P as needed to reflect social optimum, achieve AE and welfare max
• enforce strict punishments for non-adherance (fines)

Question 23

pro of regulation

Answer 23

overcomes problems of market-based policies like taxation and subsidy that may be ineffective at changing Q in the market due to inelastic demand

Question 24

problems with regulation

Answer 24

1. cost of admin and enforcement
2. info failure - setting at right level
3. inequitable impact on firms
4. cost of meeting regulation may erect BTE - reduces contestability and gives rise to another market failure

Question 25

explain why blanket regulation may be inequitable for firms

Answer 25

with a pollution cap for e.g. all firms are forced to meet pollution standards regardless of cost involved, but some firms will find it cheaper than other to do so and this may force smaller firms to shut down/relocation

this can cause unemployment – GOVT FAILURE

Question 26

explain how pollution permits are used

Answer 26

1. govt sets a max CO2 cap
2. distribute permits with a total value equal to this cap
3. creates a market for permits - draw diagram
4. firms can make the least costly decision for them - either invest in green tech or buy extra permits
5. polluter will pay in most efficient way, internalising externality
6. strict enforcement needed
7. pollution falls to social optimum - AE an welfare max
8. over time, govt will increase cap and reduce supply of permits if the scheme is successful
9. there is always LR incentive to invest (2 reasons)

Question 27

why is there always a LR incentive to invest with pollution permits?

Answer 27

1. with investment firms will no longer require their excess permits, so can sell them for a profit
2. permit prices will inevitably rise in the future as govt. reduces supply, so controlling pollution will reduce the cost burden

Question 28

pros of pollution permits

Answer 28

1. LR incentive to reduce pollution
2. more equitable and efficient for firms compared to blanket regulation e.g. pollution caps (avoid costs of shut down and unemployment)
3. reduce pollution and internalise negative externalities

Question 29

problems with pollution permits

Answer 29

1. hard to enforce by measuring pollution - incentive to cheat cap
2. info failure, quantifying externality - issuing too few or too many permits
3. price of permits may fall/be volatile - increases risk of green investment
4. price inelastic demand for pollution?
5. pollution is an intl market failure and domestic solutions may have little impact with intl. cooperation e.g. Kyoto Protocol, but very difficult to achieve this

Question 30

explain the tragedy of the commons

Answer 30

situation in which individuals with access to a common access resource act in their own interest, ultimately depleting the resource –> e.g. the sea and overfishing

this is the premise of exclusive economic zones and the sea!

Question 31

explain how allocating property rights can solve the tragedy of the commons

Answer 31

1. gives holder private ownership over a piece of land/part of sea
2. increases incentive to maintain resource otherwise it will be the owner that solely loses out from resource depletion/pollution
3. if another producer intrudes, then holder can sue them
4. over production issues are now solved with resources allocated efficiently and enabling sustainable production
5. this targets the root of the problem! - e.g. in best interests of owner of part of forest to only cut trees that maximise SR profits but not jeopardises profit making ability in LR

Question 32

problems with property rights

Answer 32

1. impractical and unrealistic for many resources
2. costly to allocate and enforce - opp cost as money could be used on a more effective policy
3. deciding who gets what is normative and challenging as one party will always lose out - rights could be held by third party govt org for e.g. which will benefit most parties

Question 33

define privatisation

Answer 33

the transfer of state owned assets to the private sector, through sale of a company, contracting out, competitive tendering or public private partnership (PPP)

explain the forms of privatisation in a little more detail in your essay. E.g. Define, then full stop, then say ‘It can take place in several forms, including…’

Question 34

define deregulation

Answer 34

the removal of legal barriers to entry in an industry, improving both contestability and actual competition

Question 35

pros of privatisation and deregulation

Answer 35

1. promote competitive outcomes - AE
2. Promote productive efficiency
3. promote dynamic efficiency
4. privatisation - revenue for govt
5. PPI projects allow govts to build new infra when a high budget deficit would otherwise not have allowed it

Question 36

cons of privatisation and deregulation

Answer 36

2. may not promote competitive outcomes if firms do not actually enter industry due to other non-legal barriers (e.g. advertising, predatory pricing)
3. loss making G/S no longer produced (MIGHT be with cross subsidisation)
4. DE gains not likely if increased competition reduces SNP
5. private firms - self interest causes market failure (e.g. -ve externalities)
6. PPI may increase LONG TERM govt debt - leasing costs - burden on citizens

4. competitive pressure may promote cost cutting at expense of quality to keep prices low (BUT not likely if firm wants to stay competitive)

Question 37

privatisation final eval

Answer 37

1. deregulation for other BTE stopping new entrants but regulation post-privatisation to prevent market failure from monopoly power and -ve externalities
2. whether it should be used depends on if it is a natural monopoly/very large firm - not efficient in this case!

3. form of privatisation used determines whether revenue generated for govt, as well as if sold at right price

Question 38

deregulation final eval

Answer 38

1. depends on other non-legal BTE stopping new entrants - deregulate as much as possible and enforce regulation to limit these other BTE (e.g. predatory pricing)
2. Regulate monopoly power and negative externalities post-dereg
3. no guarantee that efficiency gains from increased competition will occur if consumer inertia/loyalty exists and do not switch to new suppliers - govt should provide info + reduce complexity

Question 39

define nationalisation

Answer 39

the process of taking a private industry into public ownership

Question 40

pros of nationalisation

Answer 40

1. public sector more likely to be AE due to objective being social welfare and not profit max - will promote services with =ve externalities like ed/health
2. stop private natural monopolies from exploiting consumers
3. public sector more likely to promote employment and skill development
4. public sector can be vehicle for macroeconomic control - wages and inflation; employment

Question 41

cons of nationalisation

Answer 41

1. lack of competition and profit incentive to keep costs low - PE
2. lack of SNP may limit DE gains
3. cost of purchase - OPP COST
4. political priorities override commercial issues - objective of vote maximisation means capital projects with LT social benefits don’t take place if they will reduce popularity (e.g. increasing taxes to build new schools)

reater risk of moral hazard - politicians not accountable for actions, so take on more risky projects - govt failure

Question 42

nationalisation final eval

Answer 42

1. delivery of key services has benefits that outweigh costs of nation, including LR tax revenues from econ growth
2. if private sector regulation and competition is strong, nationalisation may actually increase INEFFICIENCY (unless significant market failure)
3. PPPs may be better LT solution than nation - private sector efficiency at socially desirable levels
4. ownership not as important as how the nationalised firm is managed - e.g. with incentives to workers, productive efficiency gains may occur

Question 43

explain how info provision works to solve market failure

Answer 43

depending on +ve or -ve advertising:

1. solve merit/demerit good market failure where info failure is root cause
2. better informed consumers more fully understand the benefits/costs of consumption and make more rational decisions
3. shifts MPB right/left to equal MSB
4. market reaches socially optimum quantity with UC+UP/OC/+OP issues solved
5. AE and welfare max

RATIONAL DECISIONS KEY PHRASE

Question 44

info provision eval

Answer 44

1. cost of advertising on large scale VS no guarantee of marked change - opp cost and risk of gov failure too high, better off using policies proven to be more effective. Alternatively, could use tougher policies as main measure, and reinforce with info as secondary measure - e.g. tax revenue could be hypothecated
2. No guarantee it will work - poor advertising, targeting, cultural habits may be stronger (e.g. drinking in the UK)
3. more effective in LR than SR so may need to pair with another tougher regulation with more immediate effects like ________ . This leads to both SR and LR improvement
4. perhaps seen as overly paternalistic? interfering with people’s decisions against their will, but it is ultimately in their best LT interests!

SAVE POINT 1 FOR FINAL EVAL!!!!1

Question 45

define nudge theory

Answer 45

influencing consumer choice using small suggestions and positive reinforcement so that they make more effective decisions. Is rooted in information provision

eval for nudge theory is the same as for info provision!

Question 46

define government failure

Answer 46

when the costs of government intervention to correct market failure outweigh the benefits, leading to a net loss of economic welfare

Question 47

causes of government failure

Answer 47

1. high admin and enforcement costs
2. information failure - cannot set policy at right level
3. unintended consequences and micro/macro policy conflict
4. regulatory capture

Question 48

how can info failure lead to govt failure?

Answer 48

1. quantifying externality
2. misjudging demand for a merit good leading to insufficient/excess direct provision (excess demand/wastage of resources)

Question 49

examples of unintended consequences

Answer 49

1. taxes and benefits distorting incentives
2. political objectives leading to policies desighed to win votes rather than ensure economic efficiency - e.g. road pricing or fuel taxes
3. indirect tax leading to unemployment
4. monopoly regulation erecting BTE that further reduce contestability
5. unexpected/no reaction from agent - e.g. inelastic demand for pollution from firms means little response to taxes
6. price controls increasing inequalities

Question 50

causes of regulatory capture

Answer 50

1. asymmetric info - regulators rely on firms to provide true info about costs and investment requirements
2. under-resourced - insufficient funding to scrutinise industry

Question 51

3 I’s!

3 ways to analyse whether a policy may lead to govt failure

Answer 51

1. ineffective
2. inefficient (distorting markets, incentives)
3. inequitable (affecting certain groups disproportionately)