Microeconomics 1.4 Flashcards
What is government intervention
When the government take action to correct market failure
Reasons why governments intervene
In order to:
- reduce or eliminate negative externalities
- increase or maximise positive externalities
- increase the supply of merit goods
- reduce the supply of demerit goods
- supply public goods that would be undersupplied by the market
What are price controls
When the government places restrictions on the prices that can be changed for goods and services, in the form of minimum or maximum prices.
Draw minimum and maximum price diagram
check
Minimum price (price floor)
To be affective a minimum price must be set above the normal free- market equilibrium. If it set below it has no affect
What does the imposition of a minimum price lead to
Excess supply of Q1-Q3 as firms will wish to supply more at a higher price
If a price floor is set above the market equilibrium then consumers will be forced to pay more for that good or service than they would if prices were set at free market principles
Why do governments set price floors
- To discourage consumption but typically results in an increase of supply and decreased demand
Maximum prices
A price ceiling for a market - suppliers cannot sell the products legally at a higher prices
What does the imposition of a maximum price lead to
Will lead to excess demand of Q3-Q1 as consumers will wish ti demand more at a lower price
Reasons for maximum pricing
- The good is essential for daily living - some people may be unable to afford the good. y reducing the price it can help to reduce relative poverty
- Monopoly exploitation - If firms have monopoly power they can charge higher prices: A maximum price can be a way of reducing ‘monopoly power’
- To encourage consumption (merit goods)
Evaluating maximum pricing
- They create a shortage. A maximum price distorts the market and leads to dis-equilibrium. The demand is greater than supply meaning many consumers will be unable to get the product at all.
- Encourages the black market: because of the shortages it creates the incentive to develop a ‘black market’ where people illegally trade goods. People could buy the good at the low maximum price and then resell to those customers who were unable to buy
Why would putting a maximum price on rent be an issue
A reduction in rents will discourage landlords from letting out property and may also discourage people from building houses
When does state provision occur
When the government (or state) intervenes in the market in order to supply a good or a service
What two goods/ services cause state provision
A merit goods:
- The government supplies goods and services such as education and health as society believes that these are under provided by the market mechanism
A public good:
-defence and infrastructure as they would be under provided by the private sector due to a lack of profit to be made and the free rider problem
When does regulation occur
Regulation is undertaken by the government when they create laws to correct market failure or to ensure markets remain competitive
The government believes that this will protect the interests of consumers so that they are to exploited by firms
A key reason for regulation
Regulation is used to create conditions for continued investment in infrastructure in important areas of economy
What are trade pollution permits
A form of intervention whereby government issues firms with the permission to pollute. If firms pollute less it can sell its pollution permits to other firms, however if it produces more it has to buy permits from other firms or the government
Aim of pollution permits
The aim of pollution permits is to provide market incentives for firms to reduce pollution and reduce external costs associated with it
To make pollution permits as close as possible to the social marginal cost (to make MPC>MSC, thus eliminating the negative externality of production)
How do trade pollution permits work
- The high pollutes have to but more permits, which increases their costs and makes them less competitive and less profitable
- The low polluters receive extra revenue from selling her surplus permit which makes them more competitive and more profitable
- There is a clear incentive to be a non-polluter
Is the supply of pollution permits inelastic or elastic and graph
The supply of pollution permit is perfectly inelastic
The supply of tradable permits is fixed over a year
If demand for pollution increases the cost of pollution permits increases
Draw graph
Effect of reducing the number of pollution permits over time and graph
- The price will steadily increase and create a growing incentive to reduce pollution over time
- The idea is that it gives firms time to try and invest in different technology which creates less pollution
Why do governments provide information
Often market failure results from consumers suffering from a lack of information about the costs and benefits of the products available. Government intervention should be aimed at closing the information gap
Examples of how government intervention can eliminate externalities through MPC and MPS (graph for pre and post intervention)
Imposing a tax of the correct level to make the marginal social cost and marginal private cost curves equal to each other. As a result the dead weight (welfare) loss triangle has been removed and the welfare for society has increased
Evaluate the method of taxing to make MPC and MPS
Indirect taxes increase costs, reduce supply an reduce demand due to high prices. However indirect taxes could be regressive, punishing lower income groups
