Micro part 15- Gov. intervention (2), Gov. failure

Question 1

What is info provision

Answer 1

1. Increase/decrease consumption of merit/demerit goods when consumers are more aware of social benefits/costs
2. Reduces info failure
3. Reduce presence of false advertising

Question 2

What does Gov. regulation do

Answer 2

1. Use to correct information gaps, reduce power of monopolies or reduce demerit good production
2. However can be hard to determine right level to mean efficiency is continued
3. Much regulation needs to be worldwide to be effective, constant monitoring expensive
4. Can lead to a loss of a natural monopoly
5. Can lead to regulatory capture due to information asymmetries

Question 3

How can Gov. regulation lead to a natural monopoly

Answer 3

1. reduces barriers to entry e.g. less safety requirements
2. this means new firms can enter an industry if ANP is available, but if the incumbent firm is a natural monopoly that benefits from large EoS then the entry may reduce output of each firm
3. this means may produce at an output below MES meaning a fall in productive efficiency

Question 4

What is Cost benefit analysis

Answer 4

1. a procedure used to evaluate investment projects, taking into account social costs/benefits.
2. In a free market, decisions are based on private costs/benefits

Question 5

What is the process of Cost benefit analysis

Answer 5

1. Identify all private and social costs/benefits are identified and quantified, then weighted according to importance
2. They are assigned a monetary value which is shadow pricing (monetary value assigned to something that has no value)
3. Attach probabilities to future events
4. Deduct all costs from the benefits too see if net social benefit is positive
5. Generally if there is a net social benefit then the project will go ahead

Question 6

Why is it hard to place a monetary value on an externality

Answer 6

1. this is because there is no obvious market price for many aspects e.g. intangible aspects like congestion wasting peoples’ time
2. the multiplier effect is hard to calculate from any initial injection because it is hard to predict how much money will leak from the circular flow of income
3. very different values on some aspects e.g. the value of human life
4. financial benefits from a projection will decrease in value due to inflation, so future costs and benefits must be discounted to represent present values
5. some C.B.A. only account for a limited time period but some significant costs can be present far into the future e.g. decommissioning a nuclear power plant

Question 7

What can discount rates do for investment

Answer 7

1. low discount rate might encourage investment now which can boost economic growth
2. high discount rate may reduce investment now but can protect environment and make growth more sustainable

Question 8

What are the limitations of C.B.A

Answer 8

1. doesn’t take equity into account as it may benefit one group of people more than another
2. needs to be unbiased to be effective yet if there is asymmetric information and a project is likely to benefit the group carrying out the C.B.A., then can cause market failure

Question 9

What are the overall points about C.B.A

Answer 9

1. useful for taking into account social costs/benefits that would not have been under a free market system
2. can be very imprecise making statistics unreliable. A range of calculations should be made when different assumptions are made, with these assumptions being stated explicitly
3. can be useful in giving some idea but shouldn’t be the only procedure used to evaluate an investment project

Question 10

What is government failure

Answer 10

1. when a gov. intervenes in a market causing a net loss in social welfare or a misallocation of resources

Question 11

When does a distortion of price signals occur

Answer 11

1. occurs when gov. intervention changes price signals in the market.
   E.g. when a subsidy is provided allowing high cost farmers that would otherwise be forced out of competition by imports to stay in business and make profit.
   This means consumers pay higher prices when imports would be cheaper.

Question 12

What does a distortion of price signals lead to

Answer 12

1. It creates a misallocation of resources since the farmers are growing a crop which could be used more efficiently for something else if there were no price distortions.
2. If losses to consumers are greater than efficiency gains then gov. failure
3. price controls create excess supply e.g. buffer stock means some product is destroyed or perishes as there is artificial demand so there’s a misallocation of resources

Question 13

What causes government failure

Answer 13

1. Distortion of price signals
2. Unintended consequences – consumers may react in unpredictable ways. There may be external shocks which can affect the effectiveness of policies
3. When administrative costs outweigh the welfare benefit
4. Information failure
5. Conflicting objectives

Question 14

What causes information failure

Answer 14

1. may fail to understand or acquire relevant info.
2. This means its hard to put a value on the gov. intervention needed to correct market failure e.g. may over allocate resources therefore gov. failure
3. may not know how consumers want resources to be allocated as the price mechanism is better for this

Question 15

What are conflicting objectives

Answer 15

1. may want to reduce taxes but increase spending.
2. Every decision has an opp. cost and sometimes a decision is made where the welfare gain from the alternative foregone would have been higher
3. may often favour short-term solutions to market failure as this will be more likely to increase political favourability when the positive effects are noticed
4. even if longer term solutions may have increased welfare more in the l.r. or there may be l.r. costs of the short term fix

Question 16

How does gov. intervention link to market failure

Answer 16

1. Assumed market failure should be corrected by gov. intervention
2. Extremely vital that gov. provides public goods
3. Yet at the same time due to the lack of info it is extremely hard for gov. to consistently intervene in a way which ensures there is a net gain in social welfare
4. But markets may do a better job of allocating resources due to the price mechanism

Question 17

What are consequences of gov. failure

Answer 17

1. misallocation of resources
2. allocative inefficiency
3. greater welfare loss than previous to the intervention