theme 1- 1.4 government intervention

Question 1

government intervention in markets- indirect taxes

Answer 1

may be used to deal with external costs
internalises the externality by taxing the product so that output and consumption are at a level where SMB = SMC, the socially optimum level

Question 2

advantages of indirect taxes

Answer 2

• incentive to reduce pollution- increases cost
• source of revenue for the government to compensate those affected by external costs
• few admin costs

Question 3

disadvantages of indirect taxes

Answer 3

• ineffective if demand is elastic
• difficult in discerning what tax to set due to problem of quantifying external costs
• increased business cost

Question 4

subsidies

Answer 4

may be used in the case of external benefits of production to encourage production so the socially optimal level is reached
causes a right shift in supply

Question 5

advantages of subsidies

Answer 5

• reduction in cost of production
• incentive to increase consumption
• may help reduce inequality

Question 6

disadvantages of subsidies

Answer 6

• cost to the taxpayer
• ineffective if demand is inelastic
• difficult to set an appropriate subsidy

Question 7

maximum prices

Answer 7

price usually set by the govt to make it illegal for firms to charge more than a certain price
e.g. on rented accom
results in a shortage of supply if set below equilibrium as there is higher demand but less supply + vice versa

Question 8

advantages of maximum prices

Answer 8

• enable consumers on low incomes to buy a product
• prevents increased inflation
• prevents exploitation of consumers by monopolies

Question 9

disadvantages of maximum prices

Answer 9

• danger that shortages mean some consumers are unable to access the product
• producers may exit the market to produce more profitable goods
• cost to the taxpayer
• emergence of a black market that sells at a much higher price

Question 10

minimum prices

Answer 10

price usually set by the govt which is guaranteed to producers
may set to ensure that producers receive a certain price
e.g. minimum price on alcohol in Scotland to deter consumption
the government often buys the surplus supply and stores it if the price is set above equilibrium

Question 11

advantages of minimum price

Answer 11

• producers know in advance the price they receive
• greater certainty for producers
• prevent exploitation of producers by wholesalers and retailers who have significant buying power

Question 12

disadvantages of minimum price

Answer 12

• if set too high, continual surpluses
• involves cost of storage borne by taxpayers
• encourages over-production- may result in inefficient allocation of resources

Question 13

tradeable pollution permits

Answer 13

rights to sell and buy actual or potential pollution in an artificial market
used to reduce external costs
permits are issued to firms with a limit of pollution, if it is exceeded = fines
permits can be traded between firms

Question 14

advantages of tradeable pollution permits

Answer 14

• works through the market mechanism
• incentive to reduce pollution
• low cost to administer
• can be a planned reduction of pollution over time

Question 15

disadvantages of tradeable pollution permits

Answer 15

• pollution will continue
• large efficient firms may amass lots of permits so they can pollute more
• need to be internationally enforced to be effective
• may make a country’s goods less internationally competitive

Question 16

state provision of public goods

Answer 16

response to lack of provision of public goods by the free market = govt provides them
disadvantage = politicians decide allocation, without direct reference to consumers

Question 17

provision of information

Answer 17

info gaps can be closed by the media, internet, printed info leaflets
BUT cost, no guarantee of effectiveness

Question 18

regulation

Answer 18

can be imposed on the activities of consumers and producers e.g. bans, limits on production/consumption
BUT limits consumer sovereignty

Question 19

government failure

Answer 19

when government intervention results in a welfare loss

Question 20

causes of govt failure- distortion of price signals

Answer 20

measures e.g. min/max prices undermine the price mechanism, leading to inefficiently allocated resources

Question 21

causes of govt failure- unintended consequences

Answer 21

e.g. cigarette smuggling as a result of high indirect taxes

Question 22

causes of govt failure- excessive admin costs

Answer 22

borne by the taxpayer

Question 23

causes of govt failure- information gaps

Answer 23

when the govt intervenes it is unlikely to have all the info, could move output further away from the socially optimal level

Question 24

government failure in various markets- examples

Answer 24

• high indirect taxes = smuggling
• surpluses resulting from min prices = indication of resource inallocation
• housing subsidies = limits incentive for people to move, limiting mobility of labour