Microeconomics - Government intervention in markets

Question 1

Why do governments intervene in markets

Answer 1

Governments intervene in the market to correct market failure. For example, they
might provide healthcare and education, which the free market would underprovide

Question 2

what are Indirect taxes

Answer 2

Indirect taxes are taxes on expenditure. They increase production costs for
producers, so producers supply less. This increases market price and demand
contracts. They could be used to discourage the production or consumption of a demerit good or service. For example, the government could impose a £1 tax per packet of cigarettes.

Question 3

draw a diagram for Ad valorem tax

Answer 3

Ad valorem taxes are percentages, such as VAT, which adds 20% of the unit
price. This is the main indirect tax in the UK.

Question 4

draw a diagram for specific taxes

Answer 4

a set tax per unit, such as the 58p per litre fuel duty on
unleaded petrol.

Question 5

define a subsidy

Answer 5

A subsidy is a payment from the government to a producer to lower their costs of
production and encourage them to produce more.

Question 6

positives of subsidies

Answer 6

Subsidies encourage the consumption of merit goods. This includes the full social
benefit in the market price of the good. Therefore, the external benefit is
internalised.

Question 6

positives of subsidies

Answer 6

Subsidies encourage the consumption of merit goods. This includes the full social
benefit in the market price of the good. Therefore, the external benefit is
internalised.

Subsidies encourage the consumption of merit goods. This includes the full social
benefit in the market price of the good. Therefore, the external benefit is
internalised

Question 7

draw a subsidy diagram

Answer 7

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Question 8

disadvantage of subsidy

Answer 8

The disadvantages of subsidies include the opportunity cost to the government and
potential higher taxes, the potential for firms to become inefficient if they rely on
the subsidy and government failure, if they subsidise less efficient industries.

Question 9

why might a max price be set

Answer 9

The government might set a maximum price where the consumption or production
of a good is to be encouraged. This is so the good does not become too expensive to
produce or consume.

Maximum prices have to be set below the free market price, otherwise they would
be ineffective.

Question 10

positives of a max price

Answer 10

prevent monopolies exploiting consumers. For example, in the EU, price caps
on roaming charges are in place to make sure it is not too expensive for consumers
to use their mobile phones abroad

Maximum prices control the market price, but this could lead to government failure
if they misjudge where the optimum market price should be.

Maximum prices could lead to welfare gains for consumers by keeping prices low,
and they could increase efficiency in firms, since they have an incentive to keep their
costs low to maintain their profit level.

However, it could reduce a firm’s profits, which could lead to less investment in the
long run. Moreover, firms might raise the prices of other goods, so consumers might
have no net gain.

Question 11

define a minimum price

Answer 11

The government might set a minimum price where the consumption or production
of a good is to be discouraged. This ensures the good never falls below a certain
price.

Question 12

positives of a minimum price

Answer 12

For example, the government might impose a minimum price on alcohol, so it is less
affordable to buy it. The National Minimum Wage is an example of a minimum
price.

Minimum prices would reduce the negative externalities from consuming a demerit
good, such as alcohol

Minimum prices have to be set above the free market price, otherwise they would
be ineffective.

Question 13

draw a minimum price diagram

Answer 13

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Question 14

Tradeable pollution permits

Answer 14

These could limit the amount of negative externalities, in the form of pollution,
created in industries. Firms will be allowed to pollute up to a certain amount, and
any surplus on their permit can be traded.

This means firms can buy and sell allowances between themselves.

For example, there could be a limit on the quantity of carbon dioxide emissions
released from the steel industry.

Question 15

advantages of tradeable pollution permits

Answer 15

This should benefit the environment in the long run, by encouraging firms to use
green production methods

The government could raise revenue from the permits, because they can sell them to
firms. This revenue could then be reinvested in green technology.

If firms exceed their permit, they will have to purchase more permits from firms
which did not use their whole permit. This raises revenue for greener firms, who
might then invest in green production methods.

Question 16

disadvantages of tradeable pollution permits

Answer 16

However, it could lead to some firms relocating to where they can pollute without
limits, which will reduce their production costs

Firms might pass the higher costs of production onto the consumer.

Competition could be restricted in the market, if the permits create a barrier to entry
for potential firms

It could be expensive for governments to monitor emissions

Question 17

State provision of public goods

Answer 17

The government could provide public goods which are underprovided in the free
market, such as education and healthcare. These have external benefits.

This makes merit goods more accessible, which might increase their consumption
and yield positive externalities.

It could be expensive for governments to provide education, and the government
will incur an opportunity cost of spending their revenue.

Question 18

Provision of information

Answer 18

By providing information, governments can ensure there is no information failure, so
consumers and firms can make informed economic decisions.

For example, governments might make it illegal for second-hand car dealers not to
reveal the entire history of a car, so consumers know exactly what they are buying.

This could be expensive to police.

Question 19

Regulation

Answer 19

The government could use laws to ban consumers from consuming a good. They
could also make it illegal not to do something. For example, the minimum school
leaving age means young people have to be in school until the age of 16, and
education or training until they turn 18.

This has positive externalities in the form of a higher skilled workforce.

If there was a compulsory recycling scheme, it would be difficult to police and there
could be high administrative costs. Bans could be enforced for harmful goods,
although they can still be consumed on the black market.

Firms which fail to follow regulations could face heavy fines, which acts as a
disincentive to break the rule.

It could raise costs of firms, who might pass on the higher costs to consumers