Microeconomics 1.4.1

Question 1

What is Government Intervention?

Answer 1

When the Gov intervened in market for merit/demerit goods because the free market fails to supply the socially optimum level of merit/demerit goods
They do this by affecting supply - either directly (provision of certain goods) or indirectly (taxes & subsidies which sort to decrease consumption of certain goods to the socially optimum level)

Question 2

Advantages of an Indirect Tax:

Answer 2

Internalises the externality (as market will now produce at socially optimum point & social welfare is maximised)
Raises Gov Revenue (used to solve externality in other ways such as through education - helps good become more elastic)

Question 3

Disadvantages of Indirect Tax:

Answer 3

Difficult to know size of externality (so difficult to target the tax - gov suffers from imperfect information)
Could lead to creation of black market
If good is inelastic, tax will be ineffective at reducing output
Regressive (poor spend larger proportion of their income on indirect taxes than rich do)

Question 4

Advantages of Subsidies:

Answer 4

Producers are able to produce more at a lower price - solves underconsumption/production - higher allocation of resources
Can encourage small businesses - brings about equality and encourages exports

Question 5

Disadvantages of Subsidies:

Answer 5

Difficult to target since the exact size of externality is unknown
Can cause producers to become more inefficient
Once introduced, it is difficult to remove

Question 6

Maximum Price:

Answer 6

Price ceiling - gov/industry regulator can set a maximum price to prevent the market price from rising above a certain level

Question 7

Minimum Price:

Answer 7

Price floor - for a supplier, they cannot legally sell at a lower price

Question 8

Guaranteed Minimum Price:

Answer 8

Gov will buy up any excess supply to guarantee the minimum price (e.g. some agricultural minimum prices)

Question 9

Legal Minimum Price -

Answer 9

Gov sets minimum by law - ban on sales set below - gov doesn’t buy up any surplus - e.g. price of alcohol

Question 10

Advantages of Minimum & Maximum Prices:

Answer 10

They can be set where MSB = MSC, do allow for some consideration of externalities, and so help to increase social welfare
A maximum price will ensure a good is affordable, whilst a minimum will ensure that producers get a fair price. Both of these are able to reduce poverty & can increase equity/equality

Question 11

Disadvantages of Minimum & Maximum Prices:

Answer 11

There is a distortion of price signals & causes excess supply/demand. Excess demand will lead to questions about how to allocate goods/services & excess supply will lead to questions about what to do with surplus goods
It is difficult for gov to know where to set prices, because of the difficulties of knowing the size of externalities & because it will have implications on size of excess supply/demand
Both can lead to the creation of black markets - max prices can also lead to illegal bribes or discriminatory policies in allocating goods