Policies to solve market failures Flashcards
What are property rights
process of giving a private holder ownership of a common access resource (such as sea, air and land)
Aim of using property rights
Private firms use the resource to maximise profits and with private ownership there will be a strong incentive to maintain the resource and not overproduce otherwise they could lose out on profit in the future.
What can property owners do if someone intrudes on their property?
They can sue them for trespassing and so protecting their private property that they rightfully own. Consequently stopping overproduction issue
Evaluation of property rights (practicality)
Good at promoting incentives
Difficult to assign private ownership of commons
Theoretical sound but limits in practical application
Problems of overfishing and excess pollution (eg) still exist
What are Buffer Stock Schemes
A government plan to stabilise prices in volatile markets
Are buffer stock schemes a market-based or interventionist approach
Interventionist
Aim of buffer stock schemes
protect consumers from too high prices, protect producers from too low prices to maintain living standards
Outline the process of Buffer stock schemes
Government send max and min price bands in a market
Prices too high = Governments sell stored stocks to increase supply to lower price
Prices too low = Government increase demand by buying excess stock in the market to increase price
What does a diagram for buffer stock schemes look like?
What are two types of price controls used to solve market failure
Minimum and maximum price
What are minimum prices
Price floors set above the equilibrium price in the market to discourage consumption of demerit goods but also protect producers
How can minimum prices protect producers
Producers of primary commodities which are price volatile
Minimum price provides stable income
Minimum price diagram for demerit goods
Example of when a minimum price was imposed
In 2018 the Scottish government announced a minimum price of 50p per unit of alcohol as a radical way of reducing the overconsumption of alcohol. In Scotland every adult on average drinks 20 units of alcohol a week, much more than the recommended level of 14.
Was alcohol minimum price in Scotland successful?
It has reduced consumption by around 8%. However has not seen a noticeable change in the number of alcohol related crimes being committed
Can a minimum price increase inequality?
Yes
The poor suffer proportionately greater than the rich as minimum price are regressive.
Tale a greater amount of the poor incomes, which could widen income inequality gap
When are consumers burdened more by a minimum price?
If the goods demand is price inelastic due to addictive nature of demerit goods
What are unintended consequences of a minimum price
Firms shut down or leave country causing unemployment
Black markets can form
Consumers switch to legal alternatives that are actually worse for them as they are cheaper
Can worsen negative externalities
Can result in government failure
What is government failure?
When the costs of intervention outweigh the extra benefit, leading to a further worsening resource allocation
What are 3 cons of minimum price
Increase income inequality
Can lead to unintended consequences
Setting minimum price difficulties
Why can it be difficult to set minimum price?
Putting an accurate value on a negative externality is extremely complex in reality. There are ways in which it can be done but it is not always perfect. Consequence is the min price being set too low so externalities are not internalised. If min price is set too high, unintended consequences can arrive
Cons of minimum price
Excess supply created which has to be bought up by government (intervention buying). What to do with the excess stock is the issue.
1. Storing is expensive
2. Destroying is wasteful
3. Dumping abroad is politically sensitive
Because of costly intervention buying of excess stock, this needs to be funded so can be followed by future tax rises which harm consumers.
Intervention buying
Following government intervention of a minimum price, governments create excess supply which has to be bought up by government. Called intervention buying
What is a maximum price
price ceiling set below free market equilibrium price
What does a maximum price do
Creates excess demand form an extension in demand, improving the affordability of essential goods and services.
Aims to reduce any underconsumption issues thus improving the allocation of resources.
Cons of a maximum price
Creates a shortage/excess demand
Unintended consequences (black market)
Difficulty in setting max price levels
How can a shortage be a negative consequence of a maximum price?
means some consumers will not be able to access the good because demand is greater than that supplied, despite lower prices due to suppliers either leaving the market or not willing to supply at such low prices
Consumers receive no benefit
Diagram of a maximum price solve income inequality
Real world example of maximum pricing
Rent control in New York
What is regulation
Regulations are rules or laws enacted by the government which economic agents have to operate within
How can regulation solve market failure
Starts with a rule which intends that intends to either decrease or increase consumption or production to solve market failure without using the price mechanism
What is a strength of regulation
can overcome the issues surrounding the ineffectiveness of market based approaches like subsidies and taxes, when faced with an inelastic demanded goods market
Explain makes regulation effective
There is a strong incentive for consumers and producers to follow regulation as long as the control side of the policy is strong. This involves strict punishment for those who are found breaking the regulation, like fines and negative publicity, but most crucially through strong enforcement of the policy by policing. As a result the behaviours of economic agents is adjustable to where consumption or production is increased or decreased, n as part of there aims of the regulation. As a consequence quantity in the market is reallocated to the socially optimum, where there is allocative efficiency, welfare is maximised, therefore internalising the market failure.
What are some examples of regulation
Setting legal smoking age of 18+
Price regulation through min or max price
US Motor Vehicle Air Pollution Act
National Minimum Wage
What is the NMW as of April 2024 in UK
£8.60 for 18-20 year olds
What are unintended consequences of regulation
Firms shutting down - unemployment
Firms leaving the country - unemployment
Black market creation
Government failure
evaluation of regulation (costs)
Extremely costly to enact
Administration of drawing up regulations and getting through political process and strict enforcement
If costs outweigh the benefits it leads to gov failure
Is there an opportunity cost of regulation?
If there is no surplus tax revenue
Argued whether regulation is the best use of tax payers money, especially if there are other appropriate policies which could be used instead.
What happens if government cannot afford regulation
individuals and firms know that if they were to ignore the regulation then it is unlikely that there will be caught if regulation enforcement cannot be afforded by the government
How could economic agents be harmed if government cannot afford regulation
Economic agents could be harmed with future corp and income tax rises, burdening the poor more
What are tradable pollution permits
where the government gives firms a permit which allows them to produce up to a set amount of carbon each year aiming to solve pollution based market failure
Outline process of tradable pollution permits
- First Government set a maximum level (cap) of CO2 allowed to be produced. The cap is the socially optimum
- permits are distributed out to firms
- Market for permits is created
- Firms make decisions on whether to invest in green technology or to buy excess permits from other firms
- Tradable pollution permits create incentives to reduce pollution and invest in GT so that they have excess permits left over which they can then sell to increase revenues as they are in high demand by firms that struggle to invest in GT
Diagram for tradable pollution permits
High demand for permits shifts demand out from D1 to D2 increasing price of permits to P2
Government tightens the cap and reduces number of permits handed out which shifts supply leftward from S1 to S2 increasing price to P3
Cons of tradable pollution permits
Difficult to set at the right level
Costly to enact
Unintended consequences
What is a subsidy
A subsidy is a money grant given to producers by the government to lower costs of production and encourage an increase in output
When can subsidies be used to solve market failure
When there are positive externalities to production and consumption that create underconsumption and underproduction
How do subsidies solve market failure when there is underconsumption
Gov want to maximise welfare at social optimum
In free market not the case MPB considered
Misallocation of resources
Subsidy lowers cost of production
Lower prices to consumers
Due to law of demand, consumption rises
Eliminates underconsumption as quantity increases
Positive externality has been internalised
Diagram of subsidy solving underconsumption
How do subsidies solve market failure when there is underproduction
Gov want to maximise welfare at social optimum
In free market not the case MPC considered
Misallocation of resources
Subsidy lowers cost of production
Can produce more at lower cost
Quantity produced increases
Underconsumption eliminated
Positive externality has been internalised
Diagram of subsidy solving underproduction
Evaluation points of subsidies to solve market failure
Subsidies are expensive to implement
Risk of unintended consequences
Correct level of subsidy is very difficult to set
Subsiding some markets will be completely ineffective
Unintended consequences of a subsidy
Firms using the subsidy for other factors other than to solve the market failure for example deleveraging, increasing the salaries of staff or using it to increase dividends to shareholders.
So the market failure will persist and therefore the costs of intervention outweigh the benefits and results in government failure
What is state provision
When the state provides all of the resources in a given market, free at the point of consumption, using tax payers money to fund it
What types of market failure can state provision solve?
Missing market problem with the under provision of public goods
The underconsumption and underproduction of merit goods, caused by information gaps
How can state provision help the missing market problem?
State provision allows there to be a supply of public goods, in theory at the socially optimum level of output, where otherwise in the free market they would not be provided at all due to their being no profit incentive for suppliers
Improves social welfare and solves complete market failure
What does state provision allow?
Allows for universal access to public goods like education and healthcare with these service being free at the point of consumption
Diagram showing state provision
What are the 3 cons with state provision
Large excess demand
State run organisations tend to be highly inefficient
Imperfect information when it comes to setting the right level of state provision (too less leads to excess demand, and too much is not socially desirable)
When is information provision and advertising a policy used by government?
To intervene in free markets that have positive and negative externalities where there is the overconsumption of demerit goods and underconsumption of merit goods.
Notes for paragraph on information provision.
Talk about free market consumers
Where the over or under consumption is
Deadweight welfare loss
A way to solve this…positive or negative information provision or advertising
Consumers now fully informed of cost or benefit
MPB shifts to social optimum
Externality internalised
No more resource misallocation
Market failure solved
Diagram of effect of positive information provision and advertising on underconsumption of merit good
Diagram of effect of negative information provision and adverting on the overconsumption of demerit good
MPB curve shifts left to socially optimum levels at Qs from MPB to MPB+info
What are 2 negatives of information provision and adverting
- Very costly
- No guarantee it will work as intended
Why is information provision costly?
For it to be successful, needs to be well targeted and spread out to mass media outlets increases costs considerably
Opportunity cost involved if there is no surplus tax revenue at the time.
Can be argued to whether this is the most effect use of taxpayers money, especially ifs advertising doesn’t have a noticeable impact on consumer behaviour.
Money could be used for suitable regulation instead or to help maintain regulatory bodies.
Why might information provision not work as intended?
If quality of information provided is poor
Unclear or not well targeted at the mass consumer
If not successful and with its expensive provision, this could lead to market failure
Pre-existing market failure remains and results in a worsening of resource misallocation.
RWE of Policy enacted to stop overfishing in the UK
The Sea Fisheries (Amendment) Regulation
Set in 2023
Limit to fisherman of 3.8 tonnes per vessel per year
Indirect tax diagram to solve overproduction negative externality
Indirect tax diagram to solve overconsumption negative externality
Subsidy diagram to solve underconsumption
Subsidy diagram to solve underproduction
Hypothecated tax
Indirect tax generates government tax revenue which can then be used too fund other expenditure in the economy whether that is on public service improvements like rehabilitation and addiction programs to help addiction of demerit goods or other policies to further solve market failures.
Indirect tax suitability
Paternalistic policy, government assumed to have perfect information
Arguments to whether it is a significant market failure
Restricts freedom, choice and liberty
