Theme 1 - Government Intervention To Stop Market Failure Flashcards
Government failure:
A misallocation of resources arising from government intervention.
Taxation:
Indirect tax?
Excise duty?
Indirect tax: a tax levied on the expenditure on goods and services.
Excise duty: an indirect tax on particular goods/services designed to discourage their consumption. Indirect tax is paid by the seller, so it affects the supply curve. A higher proportion of tax passed on if the product is price inelastic.
Specific tax:
Where a fixed sum is added onto the cost of the product.
Ad valorem tax:
The tax levied is a percentage of the selling price, meaning that a higher amount of tax is paid at higher prices.
Burden of taxation:
Although suppliers pay the tax levied on their goods the price goes up to consumers. For ad valorem tax it depends on the ability to add the right to tax to combat market failure. Tax is best used on price elastic goods to try and combat market as the consumer is more a larger tax is needed to get an worthy response.
Pros of taxation
- Elastic goods: it does reduce consumption.
- increases revenue for government.
- forces the polluter to pay for external costs.
- consumers still have choice in whether to consume.
Cons of taxation
- inelastic goods means consumers are willing to pay the added tax.
- depends on the size of the tax.
- hard to calculate the right level of taxation needed.
- affects low income groups more.
Unintended causes of government failure?
A result of government intervention that they didn’t intend to happen, for example putting a tax on cigarettes may cause people to smuggle cigarettes in.
Regressive tax
One which affects those on low incomes more than someone on higher incomes.
What is a subsidy and how do they work?
Subsidy: A grant given by the government to encourage the production of a good or service. They work by reducing the cost of production, the government grant them to companies that produce merit goods. It combats market failure by ensuring the external benefit of a product is paid for and that the market produces at the socially optimum point. Allocative efficiency is reached as the correct amount of products are now allocated to production.
Incidence of subsidy:
- consumer receives more of the subsidy.
- price is reduced from P to P1
- more is passed on for inelastic goods, however QD increases more for elastic goods.
Subsidies can cause government failure:
- distortion of price signals: they can become too cheap and people will disregard them as inferior.
- administrative cost: costs associated with subsides are huge.
- unintended consequences: over subscribe local facilities if you make the swimming pool free.
For subsidies
- reduces overall cost of production.
- subsidy is shared between consumers or producers.
- incentive to produce more.
- saving for society in the long run
Against subsidies
- not always shared equally
- monetary cost
- may not be used correctly
- producers become inefficient
Price controls
Maximum prices:
* A government will intervene when the price is too high and where these prices penalise lower income groups.
* They will set a price cap, or a limit.
* Example includes the university fee of £9250
* Leads to excess demand.
Minimum prices:
* They must set the minimum wage higher to alleviate poverty so workers have increased income
* Increasing the minimum wage can lead to job losses due to the increased cost of producers, it can also lead to cost push inflation. This is a government failure.
* It leads to excess supply.
