Micro part 14- Government Intervention

Question 1

When do Govs intervene

Answer 1

1. Govs. intervene in the market to correct market failure.
2. They want to increase societal welfare, increased when any costs incurred due to intervention are less than the benefits gained from intervention
3. may also want to improve equality and performance of the economy

Question 2

What is indirect taxation

Answer 2

1. Indirect – a tax on expenditure which is either specific (fixed amount charged per unit of a good) or ad valorem (charged as a proportion of the price)
2. Consumers pay a higher burden when PED is inelastic, producer pays higher burden when PED is elastic

Question 3

What are advantages of indirect taxation

Answer 3

1. -the tax raises the price of the demerit good/negative externality good because it raises the CoP since the cost of the ext. is internalised, meaning there are higher prices.
2. This means there’s a greater opp. cost of consumption so consumption is reduced and therefore negative externalities are reduced as well
3. even if doesn’t reduce demand because PED is inelastic it will mean greater tax revenue which can be used to counteract the -ve externalities

Question 4

What are disadvantages of indirect taxation

Answer 4

1. demand is not reduced if PED is inelastic
2. the tax could encourage firms to leave the country since their CoP are increased which can reduce employment
3. reduce int. competitiveness
4. can have a regressive impact since all income groups pay same amount of tax on each unit of the good, increasing inequality

Question 5

What is a subsidy

Answer 5

1. payment from the gov. to a firm with the aim of increasing production and consumption of g/s with +ve ext.
2. Can also increase int. competitiveness
   Consumers gain more when PED is inelastic, when PED is elastic then producers gain more

Question 6

What are the advantages of subsidies

Answer 6

1. the benefit of goods with +ve ext. is internalised because the cost of the ext. is covered by the gov. subsidy so the price is reduced. By reducing the price then consumer preferences are changed so demand can be increased for merit goods
2. can increase international competitiveness since CoP are reduced.
3. It can also mean that output is expanded due to access to larger markets (by being more competitive) so EoS can be experienced
4. reduce inequality by increasing access to goods as lower prices
5. can have long run impacts as it can improve factor mobility. This occurs when gov. subsidises houses so those in areas of low emp. can move to areas where there are jobs

Question 7

What are the disadvantages of subsidies

Answer 7

1. there is an opp. cost. Means money is not spent elsewhere which can also conflict with other gov. policies e.g. low taxes. Means there may be increased budget deficit
2. may make firms inefficient as they no longer rely on innovation and increasing productivity to reduce CoP (rely on subsidy). This can reduce innovation within a market.
3. has little effect on demand if PED is inelastic

Question 8

What is a maximum price control

Answer 8

1. price set below the free market price if the market price is too high

Question 9

What are the advantages of maximum price control

Answer 9

1. increases access to goods which can increase equality or increase consumption of merit goods
2. prevent monopolies from exploiting consumers
3. If below market prices then reduce profits for firms. This can encourage efficiency as firms want to reduce CoP in order to maintain profit levels. This can lead to technical efficiency

Question 10

What are the disadvantages of maximum price control

Answer 10

1. when PED is elastic then will create excess demand. 2. This can lead to rationing of the good meaning many consumers don’t have access to the good, which can reduce societal welfare and mean consumers cannot maximise their utility if have to purchase worse alternatives
2. reduce profit levels of firms which can reduce dynamic efficiency, since investment takes funds and they may lack these.
3. This can mean reduced innovation so product quality doesn’t increase

Question 11

What is minimum price control

Answer 11

1. price set above the market price.

Question 12

What are the advantages of minimum price control

Answer 12

1. when a too low of a price is having negative economic consequences on certain low income producers of such good e.g. farmers, then set minimum price to reduce inequality and ensure they have higher incomes
2. protect against predatory pricing strategies from monopolies that are aiming to reduce competition
3. reduce the demand for demerit goods when PED is elastic

Question 13

What are the disadvantages of minimum price control

Answer 13

1. there is often excess supply because firms are encouraged to expand their output as there is now a guaranteed higher price (assuming gov. purchases the excess supply).
2. This creates a misallocation of resources since often this excess supply is destroyed
3. consumers pay a higher price for the good, reducing consumer surplus and equality

Question 14

What is a Buffer stock scheme

Answer 14

1. where an organisation (usually gov.) buys and sells a good in the market so as to maintain a minimum and maximum price – increased stability
2. If supply increases then prices decreases so gov buys the good to create artificial demand so the price rises, and the stockpile of the good increases
3. If demand increases then price increases, so gov. sells from stockpiles to reduce price
4. Whilst price is between max. and min. then no action is taken

Question 15

What are the advantages of a buffer stock scheme

Answer 15

1. creates stability and a guaranteed income which can increase investment
2. the income for the gov. from selling the good at the max. price should pay for the purchasing of the good at min. price and running of the scheme, meaning there is little opp. cost

Question 16

What are the disadvantages of a buffer stock scheme

Answer 16

1. there is moral hazard where firms will overproduce as they know this will be bought by the gov.
   This incurs greater cost for the gov.
2. Also means a misallocation of resources since the price mechanism cannot work correctly as consumer preferences are not signalled accurately, but instead the gov. creating artificial demand
3. If the good is perishable then cannot make revenue from selling it.
4. Also means the stockpile is lessened which harms the ability of the gov. to maintain a maximum price if doesn’t have enough to sell

Question 17

What is state provision

Answer 17

1. Provide public and merit goods.
2. public underprovided since free-rider problem
3. merit underprovided due to the positive externalities not being realised by consumers
4. Uses tax revenue to pay for goods and provide them at a low cost/free.
5. Do this because they are motivated by societal welfare and not profit
6. Can either provide directly or purchase from private sector

Question 18

What are the advantages of state provision

Answer 18

1. increase access to good, which increases consumption of merit goods
2. redistribute income since it is the higher earning tax payers that pay for the majority

Question 19

What are the disadvantages of state provision

Answer 19

1. may operate inefficiently when provided by the state. 2. This is because there is no profit motive to reduce costs. This can create x-inefficiency
2. may overprovide certain goods, especially when the good is free of charge to tax payers.
3. This is because the gov. cannot easily respond to consumer preferences since the price mechanism cannot work if there is no price.
4. This can create a misallocation of resources

Question 20

What is privatisation

Answer 20

1. the transfer of ownership of an industry from the public sector to private
2. Firms owned by the gov. usually act in the best interest of consumers since their aim is to maximise societal welfare.
3. This means prices tend to be low and output high since don’t need to make profits
4. yet may create inefficiencies as lack competition and a profit motive

Question 21

What are Public Private Partnerships

Answer 21

1. where the gov. works with a private firm to provide a g/s.

Question 22

What are the advantages of privatisation

Answer 22

1. there may be more competition which increases efficiency and reduces x-inefficiency.
2. resources can be better allocated as the price mechanism can work. This means consumer preferences can be better satisfied since private firms have an incentive to provide quality good that consumers demand (otherwise consumers would buy goods from other firms)
3. gov gains tax revenue from selling the firms

Question 23

Why may there be more competition with privatisation

Answer 23

1. Occurs because firms want to be competitive in the market so need to reduce prices by lowering costs.
2. Even if competition was lacking, still an incentive to cut costs as motivated by profit

Question 24

What are the disadvantages of privatisation

Answer 24

1. when a public monopoly becomes privatised it becomes a privatised monopoly, which can lead to [disadvantages of monopoly e.g. higher prices, lower output]. This can incur greater costs if the private monopoly now needs regulating
2. privatised firms have less focus on health and safety
3. nationalised industries may be more productively efficient.
4. if there are many competing privatised firms then they may engage in advertising.
5. nationalised industries will often putter greater weight on factors like the environment being harmed by -ve ext. since they act in the interest of society.

Question 25

Why do privatised firms have less focus on health and safety

Answer 25

1. as more focused on reducing costs in order to increase profit.
2. Can create health problems which increases burden/spending on healthcare services by the gov. This because they are profit driven and lack social responsibility

Question 26

Why might nationalised firms be more productively efficient

Answer 26

1. When there are many competing firms in an industry with a large MES relative to market demand then no firms can benefit from EoS.
2. If there’s just one public firm then can benefit (natural monopoly).
3. This means EoS can be achieved if there’s just one firm.
4. There is also less waste as there is no duplication of resources e.g. pipe networks going similar places.
5. This means lower AC so lower prices for consumers

Question 27

Why may advertisement for privatised firms be a disadvantage

Answer 27

1. This can be seen as wasteful spending and increasing the CoP of firms without improving quality of good, instead just raising prices.

Question 28

What is competition policy

Answer 28

1. aim to protect the interest of consumers by promoting competition and encouraging market to operate more efficiently

Question 29

When do Gov. choose to intervene in concentrated markets

Answer 29

1. where monopoly power is causing market failure e.g. if prices are set above market equilibrium then there is a deadweight loss

Question 30

When might Gov control mergers

Answer 30

1. there is a significant lessening of competition
2. provide certain conditions that are to be met e.g. selling off another part of a business
3. this can prevent a monopoly arising

Question 31

How can else can Gov. increase competition

Answer 31

1. Prevent collusion in oligopolistic markets
2. Break down barriers to entry and raise contestability and boost market supply
3. Improved competition can increase dynamic and technical efficiency

Question 32

How can gov. control monopolies

Answer 32

1. price caps (e.g. P = MC)

2. decrease barriers to entry

Question 33

How can price caps help to control monopolies

Answer 33

1. encourage cost cutting by improving technical efficiencies to maintain profit but may mean less funds available as can’t operate where MC = MR so dynamic efficiency falls.
2. This can mean price is higher/output lower than if there were no price caps

Question 34

How can decreasing barriers to entry help gov. to control monopolies

Answer 34

1. to enable more firms to enter if there is ANP or make the market more contestable.
2. This competition can cause monopolies to remain efficient to stay profitable in the market.
3. Yet ineffective when there is a natural monopoly because there are such high fixed costs that barriers to entry are still large and cannot be easily reduced