THEME 1, Government Intervention (1.4) Flashcards
What are the advantages of indirect taxation? (externalities)
- It internalises the externality- market is at social equilibrium and social welfare is maximised
- It raises GOVt revenue
What are the disadvantages of indirect taxation? (externalities)
- It is difficult to know the size of the externality and so it is difficult to target the tax
- There could be a conflict between the GOVt goal of raising revenue and solving the externality
- Black markets
- Taxes are politically unpopular
- If good is inelastic, tax may be inefficient
- They are regressive
Examples of indirect taxes used for externalities in the UK
- Landfill taxes
- Fuel duties
- Alcohol duties
- Tobacco duties
- Sugar taxes
- Air passenger duties
Advantages of using subsidies (externalities)
- Society reaches social optimum where social welfare is maximised
- Encourages small businesses, equality and exports
Disadvantages of using subsidies (externalities)
- GOVt has to spend a large amount of money - opportunity cost
- Difficult to target as the size of the externality is unknown
- Subsidies can cause producers to become inefficient
- Difficult to remove once enforced
Examples of subsidies in the UK
- Biofuels
- Solar panels
- Apprenticeship schemes
- Wind farms
- Rail industries
When do maximum prices have an effect?
- When they are below the current price equilibrium
- Causing quantity demanded to exceed quantity supplied
When do minimum prices have an effect?
- When they are above the current price equilibrium
What is a maximum price?
- A legally imposed price ceiling for a good
- Suppliers cannot exceed it
- One aim of a maximum price might be to prevent the monopolistic exploitation
For what type of externality are maximum prices used?
Positive externalities
Examples of when maximum prices are used
- Rent controls e.g. Manhattan to protect tenants from being exploited by landlords
- Utility price caps
- Payday loan interest caps
Define a price control
A price control is when government laws regulate prices instead of letting market forces determine prices
Advantages of maximum prices
- They can help low income consumers to afford key products, such as rental housing (by lowering their price)
- They can reduce inequality
- They can reduce exploitation of consumers, especially where a lack of competition (monopolies) exist, leading to consumer welfare gains
- Incentivises firms to cut costs to maintain profits (efficiency gains)
- Increases demand for merit goods
Evaluation points for subsidising healthy foods to reduce the quantity demanded of junk food
- As a subsidy costs the GOVt money, they may have to cut spending on other solutions such as an advertising campaign promoting healthy eating (there’s an opportunity cost)
- Healthy foods and junks foods are weak substitutes as some consumer may be addicted to unhealthy food inelastic demand
Disadvantages of maximum prices
- Inefficent allocation of resources as government intervention distorts the operation of the price mechanism - shortages are created by a contraction of supply and extension of demand
- Black markets created
- Difficult for the government to monitor and enforce maximum price controls in markets
- Producers may exit the market as it isn’t profitable and so subsidies may need to be given to increase supply
Examples of alternative forms of government intervention to a maximum price
- Measures to reduce entry barriers in an industry
- Higher taxes on monopoly profits e.g. a windfall tax
What is price distortion?
- GOVt interventions, can distort price signals in markets.
- Distorted prices may not reflect true supply and demand conditions, leading a misallocation of resources.
What is a windfall tax?
A levy imposed on companies that have benefited from something they were not responsible for
Define a minimum price; what is the aim of this government intervention
- Price floor set by Govt on a good which it cannot exceed
Examples of minimum price schemes
- Price floors in commodity markets to protect the income of farmers
- National minimum wage to prevent exploitation
- On goods with high external costs e.g. alcohol MUP
Advantages of minimum prices
- Discourages consumption of demerit goods
- Encourage producers to switch to healthier options
- Can reduce fluctuations in prices
Disadvantages of minimum prices
- Inefficient allocation of resources
- May mean that suppliers exit the market (deepens market failure)
- Regressive
- Won’t be as effective for inelastic demanded goods
- Difficult to enforce
Define a guaranteed minimum price
- A guaranteed minimum price is where the surplus output created is purchased by a government agency at the minimum price
- Main aim is to protect producer incomes
Advantages of minimum price schemes in agriculture
- Guaranteed minimum price can stabilise and increase producer incomes
- Food surpluses can be used as a form of international aid to other countries
Disadvantages of minimum price schemes in agriculture
- Opportunity cost
- Storage costs
- Competition decreases
- Encourages inefficiency as farmers are guaranteed an income either way
- Discourages technological advancements
What are the different methods the government could undertake to correct market failure?
- Indirect taxation
- Subsidies
- Maximum prices
- Minimum prices
- Trade pollution permits
- Provision of information
- Provision of public goods
What is meant by ‘internalising the externality’?
An attempt to deal with an externality by bringing the external cost or benefit into the price system.
Define a tradable permit scheme
A tradable permit scheme is a scheme where a limit is placed on firms’ carbon emissions through the issue of permits
An example of tradable pollution permits
In 2005, the European Commission set up an Emissions Trading System (ETS) in an attempt to limit greenhouse gas emissions from heavy industry
Disadvantages of regulations
- Cost to GOVt to enforce it (expensive)
- Cost to firms
- Black market creation
- Unintended consequences
What is regulatory capture?
- When regulators act in the interest of firms rather than the public
Examples of regulators
- OFSTED
- OFQUAL
Define government failure
Government failure is when governments intervene to solve market failure but it results in a further misallocation of resources and a net welfare loss
What are the main types of government failure?
- Unintended consequences
- Excessive administration costs
- Distortion of price signals
- Information gaps
Why does the distortion of price signals cause government failure?
Undermines some parts of the price mechanism such as signalling, rationing and incentives, meaning resources are not allocated efficiently.
What is red tape?
Excessive administration
Possible diagram for regulation
Inward shift of supply (higher price and lower quantity demanded)
What can an emissions charge for high-polluting vehicles be seen as?
It can be seen as a HARD BEHAVIOURAL NUDGE, designed to change the behaviour of vehicle users
Examples of possible GOVt failure from imposing quotas and tariffs on imported steel
- Higher cost of steel could make building new homes more expensive (cost for firms increases)
- Risk of trade war
- Domestic firms are sheltered from competition
