Theme 1: Introduction to markets and market failure

Question 1

What is the basic economic problem and opportunity cost? (1.1) (2)

Answer 1

-The basic economic problem is that we have unlimited wants, but limited resources, forcing us to make a choice, leading to scarcity and opportunity cost
-Opportunity cost is the next best alternative foregone when making a choice

Question 2

Why do economists use models, and what is ceteris paribus? (1.1) (4)

Answer 2

-Economists use models to make predictions about the future direction of the economy
-a partial model looks as aspects of the economy, whereas a macro model looks at the whole economy

-When making the models, assumptions have to be made when analysing a specific cause/consequence
-Ceteris Paribus is the assumption that ‘all other things remain unchanged’

Question 3

What is specialisation? (1.1) (2)

Answer 3

-Specialisation is when individuals, firms regions and countries focus on producing what they are best at doing so, to maximise output and profit
-The division of labour is the separation of the work process into a number of smaller tasks, each task performed by a separate person/group of people

Question 4

What is a command economy, and what are the pros and cons of one? (1.1) (8)

Answer 4

-A command economy is one where the government dictates the production of goods and prices, and controls their distribution, wages and prices
-The four key components of a command economy are: government control of key business, government control of property rights, government control of wages/prices and a strong black market

+The government can change what is produced based on the needs of the people
+There is very low unemployment in a command economy
+There is very low inequality in a command economy

-A command economy discourages efficiency and innovation by firms
-Workers do not get to choose what work they do
-A strong black market leads to crime

Question 5

What is the difference between a positive and normative statement (1.1) (2)

Answer 5

-A positive statement is one which can be proven/disproven, made based on fact and not valued judgement (objective)
-A normative statement is one which cannot be proven/disproven, made based on valued judgement and not fact (subjective)

Question 6

What is productivity? (1.1) (2)

Answer 6

-Productivity is the measure of the efficiency with which a country combines factors of production to produce more with the same level of factor inputs
-Calculated with output per unit of input

Question 7

What is a free market, and what are the pros and cons of one (1.1) (8)

Answer 7

-A free market is an economic system based on the interaction of supply and demand, with little/no government intervention
-A free market is characterised by: freedom of enterprise, property rights, a competitive market and profit as an incentive

-A free market encourages efficiency and innovation
-Consumers control what is produced through their choices
-Invisible hand provides natural regulation

-Poor working conditions, as firms prioritise profit
-Vulnerable to heavy recessions with little solution
-People not useful for production purposes (elderly, disabled …) get left behind

Question 8

What causes a shift in the PPF (1.1) (7)

Answer 8

-A shift in the PPF is caused by a change in the quality/quantity of factors of production

-Changes in the working age population
-Changes in education/training

-Changes in international trade of capital
-Changes in innovation

-Natural disasters like floods and droughts
-Discovery of raw materials

Question 9

What are the positives and negatives of specialisation for workers and firms (1.1) (8)

Answer 9

-Workers can do something they enjoy, and are good at
-Workers can increase their productivity, leading to increased output and increased wages

-Workers may get bored of doing the same thing every time
-If their work is no longer needed and they lose their job, workers will find it harder to retrain

-Firms can increase their productivity, therefore increasing output and therefore profit
-By increasing productivity, firms need less FOP’s than before, decreasing costs of production

-If one part of the production process fails, the entire system collapses
-If demand for the produced good falls, firms revenue will drop with no easy way to switch production

Question 10

What are the pros and cons of specialisation of regions and countries (1.1) (8)

Answer 10

-Specialisation leads to higher output, leading to more demand for workers and decreased unemployment
-Higher incomes in the area leads to higher spending and council tax in the area, all of which will improve it

-Increased production may also come with over-abstraction of resources
-If demand for the specialised good falls, the region may collapse

-Higher specialisation allows countries to increase tax revenue, and pay back some of their government debt
-Higher specialisation leads to higher output and higher GDP

-Revenue from that good is dependant on international trade, and therefore any foreign restraints/recessions may hit the country hard
-Over abstraction of raw materials

Question 11

What is a PPF (1.1) (2)

Answer 11

-A production possibility frontier represents the maximum combination of 2 goods/services that an economy can produce at a given point in time with all resources fully and efficiently employed
-The boundary represents scarcity, and movements represent opportunity cost

Question 12

What is a mixed economy, and what are the pros and cons of said system (1.1) (8)

Answer 12

-A mixed economy is an economy with a mix of capitalism and socialism, allowing for both private and state enterprise
-The role of the government is to provide regulatory framework, ensure the welfare of the population and redistribute incomes

-Market economies encourage innovation and efficiently
-Governments have the power to decrease monopolisation
-Tax and Government spending can help redistribute incomes

-There will still be an emphasis on profit, and all the issues that arise with that
-With government intervention it is likely not maximum efficiency
-There is likely to be high income inequality in a mixed economy

Question 13

What is demand (1.2) (5)

Answer 13

-Demand is how willing and able consumers are to buy goods and services at a given price at a given point in time
-Derived demand is demand for one good which comes from the demand for another (bricks and houses)

-Demand is downwards sloping since:
-As prices fall, consumers willingness and ability to buy rise
-Diminishing marginal utility (As consumption rises, additional utility falls and therefore the price willing to pay falls)

Question 14

What is price elasticity of demand (1.2) (2)

Answer 14

-Price elasticity of demand is the responsiveness of quantity demanded to a change in price
-PED is calculated with %change QD / %change P

Question 15

What factors cause a shift/movement on the demand curve (1.2) (8)

Answer 15

-A movement on the demand curve is caused by a change in price

-shifts are caused by PASIFIC
-Population
-Advertising
-Substitutes
-Income
-Fashion and trends
-Interest rates
-Complimentary goods

Question 16

What are some factors affecting price elasticity of demand (1.2) (5)

Answer 16

-In the long run, PED is more likely to be elastic as consumers can look for other alternatives
-The larger the % of income a good is, the more elastic it will be
-If the good is a necessity, demand will be inelastic
-If the good is addictive, demand will be inelastic
-If there are many ready alternatives of high quality, the good will be elastic

Question 17

What are some PED values (1.2) (5)

Answer 17

PED is always negative

0 = Perfectly inelastic
0>x>-1 = inelastic
-1 = unitary elastic
-1>x>-∞ = elastic
-∞ = perfectly elastic

Question 18

What are different types of income elasticity goods, and how do firms use this info (1.2) (3,2)

Answer 18

-Goods with a negative YED are inferior goods, typically low cost low quality, where demand falls as income rises
-Goods with a YED 0<x<1 are normal goods, where demand rises as income does
-Goods with a YED>1 are luxuries, goods which demand largely rises as incomes rise

-In a recession, firms are more likely to produce inferior goods
-When the economy is doing well, firms will produce more luxuries

Question 19

What is the difference between price elastic and inelastic (1.2) (3,3)

Answer 19

-Price elastic demand is when quantity demanded is very responsive to a change in price
-%change QD > %change P
-Firms with elastic demand should decrease the price to maximise revenue

-Price inelastic demand is when quantity demanded is not very responsive to a change in price
-%change QD< %change P
-Firms with inelastic demand should increase the price to maximise revenue

Question 20

What is cross elasticity of demand (1.2) (2)

Answer 20

-Cross elasticity of demand is the responsiveness of quantity demanded of one good to a change in price of another
-%change QD of good A / %change P of good B

Question 21

What is the difference between a shift and a movement on a demand curve (1.2) (2)

Answer 21

-A shift on the demand curve is caused by non price factors
-A movement on the demand curve is caused by price factors

Question 22

What are some types of XED goods (1.2) (3,3,2)

Answer 22

-Goods with a positive XED are substitute goods
-For example, Pepsi and Coke
-if XED>1, then they are strong substitutes, otherwise they are weak ones

-Goods with a negative XED are complimentary goods
-For example, fish and chips
-if XED<-1, they are strong compliments, otherwise they are weak ones

-Goods with an XED of 0 are unrelated
-For example, cars and milk

Question 23

What is income elasticity of demand (1.2) (2)

Answer 23

-Income elasticity of demand is the repsonsiveness of quantity demanded to a change in income
-%change QD / %change income

Question 24

What factors cause movements/shifts of the supply curve (1.2) (1,7)

Answer 24

-A movement on the supply curve is caused by a change in price of a goods

-A shift on the supply curve is caused by non-price factors, being
-Productivity
-Indirect tax
-Number of firms
-Technology
-Subsidies
-Weather
-Cost of production

Question 25

What is supply, and why is it upwards sloping (1.2) (1,2)

Answer 25

-Supply is how willing and able firms are to produce goods and services at a given price level in a given time period

Supply is upwards sloping since:
-As prices rise, firms can offset more costs of production, being able to produce more
-Higher prices acts as an incentive for higher production, as firms could gain higher profits

Question 26

How do subsidies, weather and cost of production impact supply (2.1) (3,2,3)

Answer 26

-Subsidies are whena government pays part of the cost to the firm
-This leads to decreased costs of production to firms, and increased supply
-However, it depends on the extent of the subsidy, and how long it is given

-Weather impacts costs of production as poor weather leads to increased resource prices, and increased costs of production, leading to decreased supply
-This is heavily dependant on which sector you work in, agriculture being the one most impacted by weather

-Cost of production impacts supply since a decrease in the cost of production allows firms to supply more with the same resources, increasing supply
-However is this decrease in the cost of production short term or long term
-Firms may not want to increase supply, and decide to hoard the profits, as lower prices could be a sign of a recession

Question 27

What is price elasticity of supply + PED values (1.2) (2,5)

Answer 27

-Price elasticity of supply is the responsiveness of quantity supplied to a change in price
-%change QS / %change P

All PES values are positive
0 = perfectly inelastic supply
0<x<1 = inelastic supply
1 = unitary elastic supply
1<x<∞ = elastic supply
∞ = perfectly elastic supply

Question 28

What is producer and consumer surplus, and how would you illustrate this (1.2) (2,1)

Answer 28

-Producer surplus is the difference between the market price received and the price the producer is willing and able to supply at
-Consumer surplus is the difference between the market price paid and the price the consumer is willing and able to pay

-These surpluses are illustrated by drawing a supply demand diagram, drawing horizontally from the equilibrium to the axis, and anywhere above this line trapped by the axis and the demand curve being the consumer surplus, and anywhere below equilibrium trapped by the supply curve and the axis being the producer surplus

Question 29

What is an indirect tax, and what are the 2 types (1.2) (1,2)

Answer 29

-An indirect tax is a tax on expenditure, paid to the authorities by the producer

-A specific tax is when the tax is added onto the quantity of a good purchased, for example excise duties
-An ad valorem tax is when the tax payable increases with proportion to the price of the good, such as Value Added Tax

Question 30

What are the 3 reasons consumers may not act rationally (1.2) (2,2,2)

Answer 30

-Consumer error at computation
-This occurs especially when bulk buying, and when consumers think they have the best deal in terms of price and utility, but they do not

-Habitual behaviour
-This is when consumers do things out of habit, such as buying from the same providers, due to ease, when in reality there are newer options which would be more rational

-Herd behaviour
-This is when people follow fashion and trends which they do not necessarily agree with, but they do it to fit in

Question 31

What are some factors affecting price elasticity of supply (1.2) (5)

Answer 31

-In the long run, PES will be more elastic since firms will be able to shift production
-If a good is capital intensive it will be more elastic, since it is easier to shift capital then labour
-If there is a lot of spare capacity, a good will be more elastic, since firms will have more resources to instantly allocate to a certain goods production
-If there is available skilled labour, then a good will be more elastic, since firms can easily higher more workers to increase output
-If a good is relatively simple to produce in terms of what it needs, it will be more elastic, as less resources will need to be sourced before increasing supply

Question 32

What is the impact of indirect taxes/subsidies on the economic agents (1.2) (3,3)

Answer 32

-An indirect tax aims to increase costs of production, and decrease supply
-An indirect tax will cause an inwards shift of supply, therefore causing price to rise and quantity to fall
-The government will experience a rise in revenue

-A subsidy aims to decrease costs of production, and increase supply
-A subsidy will cause an outwards shift of supply, therefore causing price to fall and quantity to rise
-The government will experience a rise in government spending

Question 33

How do ad valorem and specific taxes look on diagrams, and how to illustrate consumer burden (1.2) (2,2)

Answer 33

-A specific tax causes an inwards shift in supply, causing a parallel s1.
-An ad valorem tax causes an inwards shift of supply, but it is not parallel as the gap widens as price does

-To draw consumer and producer burden, you create a rectangle of p1, p, s1d and e1s. You then draw across from the initial equilibrium, and anything above this in the rectangle is consumer burden, anything below this in the rectangle is producer burden
-If demand is perfectly elastic, or supply perfectly inelastic, the firm will pay all of the price

Question 34

What is the incidence of indirect taxes on consumers and producers (1.2) (2)

Answer 34

-Although the producer should pay the indirect tax, the incidence is that some of this cost will be moved onto the consumer
-The extent of this depends on the elasticity of demand (inelastic = higher consumer incidence)

Question 35

How are rationing, incentives and signalling functions of the price mechanism (1.2) (3,3,2)

Answer 35

-Rationing occurs when demand outstrips supply, as prices are too low
-Prices are risen, so that less consumers are willing/able to purchase, and more producers are willing/able to produce
-These prices are risen to a point where demand=supply, and this price is now a new equilibrium

-Profits act as an incentive to firms to increase output
-Low prices incentivise higher consumption, high prices incentivise higher production
-Workers are incentivised to work harder for increased wages

-Signalling is when the price mechanism acts as a signal to producers
-High prices signal to firms to increase output, in order to maximise profit

Question 36

How do productivity, indirect tax, number of firms and technology impact supply (1.2) (3,2,2,2)

Answer 36

-Increased productivity leads to increased output with the same input, and therefore an outwards shift of supply
-Is this rise in productivity a long term rise, or just a sudden spike
-Is this rise in productivity going to be offsett by something like a pandemic

-A rise in indirect taxes causes an increase in costs of production, and a decrease in supply
-How large are these taxes, and what type of taxes are they

-An increased number of firms increases the amount of firms producing, increasing supply
-Are these firms in it for the long run, or are they just quickly gaining money and going

-Higher quality technology leads to increased productivity, leading to increased output
-How good is this technology in comparison to what we currently have

Question 37

How can you illustrate the producer and consumer subsidy (1.2) (3)

Answer 37

-Draw a supply and demand diagram, with supply shifting outwards
-Draw horizontal from the new equilibrium, vertical from the new equilibrium to a point on the old S curve, and horizontally from that new point
-Draw horizontally from the old equilibrium, anything above that is the producer gain, and anything below that is the consumer gain

Question 38

What are the types of marginal benefit, and how do you illustrate a graph (1.3) (3,1)

Answer 38

-Marginal benefit is the additional utility gained form each additional consumption of a good/service
-Marginal private benefit is the additional utility gained to the individual from each additional consumption of the good/service (a demand curve)
-Marginal social benefit is the additional utility gained to society from each additional consumption of the good/service

-To illustrate this, draw a downwards sloping curve as the MPB, and draw a downwards sloping curve above it, where the distance between the 2 rises with output, and this is the MSB curve

Question 39

What are information gaps (1.3) (2,1)

Answer 39

-Information gaps exist when the buyer/seller does not have access to the information required to make a fully informed decision
-For example, when taking drugs people may be unaware of the long term costs

-Information gaps are a type of market failure, since they lead to people not choosing the purchase which gives them the most utility, and therefore resources are not allocated the most efficiently

Question 40

What are indirect taxes, and how can they help eliminate external costs (1.3) (2)

Answer 40

-Indirect taxes are taxes on expenditure, paid to the third party authorities by the producer
-Indirect taxes help to eliminate external costs by shifting the MPC curve inwards, subsequently causing a decrease in output to the QSOP

Question 41

How do tradeable pollution permits work (1.3) (4)

Answer 41

-The government decides on a set amount of pollution they want produced, and allocate a certain number of pollution permits to this number
-These permits are sold/given to firms, who are now legally allowed to produce this level of pollution
-Firms can either choose to invest in greener tech, decrease pollution and sell the permits, or to maintain polluting as they are, but buy more permits, increasing their costs of production
-Firms will choose which one of the 2 ways to do depending on what’s more profitable for them, but either way it will decrease pollution output

Question 42

What is a public good, and what is a free rider (1.3) (3,2)

Answer 42

-A public good is one where its use by an individual does not stop other from using it, and its consumption does not reduce the amount available for consumption by others
-One which is non-rival and non-excludable
-For example, a street lamp

-A free rider is someone who does not pay for the public good, but still benefits from it, due to its non-excludable nature
-This disincentives firms from producing these merit goods, and therefore the government has to step in, to ensure these goods are produced

Question 43

What are the types of market failure (1.3) (9)

Answer 43

-Public goods: goods which are non-rival and non-excludable
-Inequality: inefficient allocation of resources leads to unequal provisions
-Merit goods: people underestimate the value of a good
-Monopoly: one firm controls the market and can set higher prices
-Factor immobility: Factors of production unable to change occupations/locations
-Agriculture: volatile weather, fluctuating prices and pollution
-Cyclical instability: recessions and inflationary booms
-Externalities: third part costs/benefits of production
-Demerit goods: people underestimate the cost of a good

Question 44

How is a lack of education and framing issues examples of information gaps (1.3) (4,4)

Answer 44

-A lack of education leads to people being unaware of the costs/benefits of a good, and therefore they likely don’t make the right decision
-For example, when consuming drugs people may not be aware of the long term costs
-However, there is a time lag in educating people
-This can be solved with standardised packaging, with warnings on the labels

-When purchasing goods, consumers may be misled based on how goods are advertised
-A good may be advertised with low added sugar, but it may have high natural sugars
-However are firms lying, exaggerating the truth, or selling their product
-This can be solved with regulatory bodies ensuring the information is accurate

Question 45

How to illustrate external benefit/external loss on diagrams (1.3) (2,2)

Answer 45

-Draw a graph with a MSC, MPC and MPB=MSB curve
-Draw up from the MPC=MSB curve to the MSC curve, and the area of those 2 points, and the MSC=MSB equilibrium

-Draw a graph with a MSB, MPB and a MSC=MPC
-Draw up from MPB=MSC until you reach MSB, and the area between those 2 points and MSB=MSC is the area

Question 46

What are subsidies, and how can they be used to eliminate external cost (1.3) (2)

Answer 46

-Subsidies are when the government pays part of the cost to the firm, in order to decrease costs of production and increase output
-They can be used to eliminate external costs by shifting out a firms supply curve, to ensure goods with external benefits are produced in greater quantity

Question 47

What is a private good, and what is a quasi-public good (1.3) (3,2)

Answer 47

-A private good is one where its use by an individual stops others from using it, whilst its consumption reduces the amount available for consumption by others
-One which is rival and excludable
-For example, a private car park

-A quasi-public good is a private good which can take on some of the characteristics of a public good
-A road, park etc

Question 48

What are the drawbacks of subsidies (1.3) (3)

Answer 48

-For goods with inelastic supply, price will have to be reduced a lot to have the desired impact on quantity
-As with any other government spending, there is the opportunity cost of what the subsidy could’ve been spent on
-There are issues when estimating how large a subsidy should be, and what effect will it have, as well as the net welfare loss

Question 49

What is market failure and bounded rationality (1.3) (2,1)

Answer 49

-Market failure occurs when the free market fails to allocate resources at the socially optimum level, leading to inefficient outcomes and a net welfare loss to society
-The main types are externalities, information gaps and under provision of public goods

-Bounded rationality is when consumers are unable to make rational decisions which would maximise their utility, due to information gaps or other issues

Question 50

What is an externality (1.3) (2,2)

Answer 50

-An externality is a third party cost/benefit of an economic transaction, not included in the initial market mechanism
-This leads to the under/overproduction of goods/services, so resources aren’t allocated efficiently

-Externalities of production are costs/benefits to third party agents not involved in the initial economic transaction
-Externalities of consumption are third party costs/benefits that occur as a result of the actions of separate agents

Question 51

How are failures to disclose information, and difficulties in estimating costs and benefits market failures (1.3) (4,4)

Answer 51

-When an economic transaction is occurring, the economic agents may not provide all the necessary data
-For example, when buying something second hand you rarely know all the faults of it
-However, it is difficult to prove one party knows more than the other
-These can be fixed with reviews, where people can rate economic agents on reliability

-When consuming/producing a good, it is difficult to know the true social costs of the good
-For example, it is hard to put a price on pollution, since its hard to monetarily value pollutions impacts, as well as us not knowing the true long term effects
-However, external shock factors and events may change our perceptions on certain things
-This can be solved with the government providing support if there are any external shocks

Question 52

What is symmetric and asymmetric information (1.3) (2)

Answer 52

-Symmetric information is when the buyer and seller have potential access to the same information, and therefore are able to make rational decisions
-Asymmetric information is when the buyer and seller do not have potential access to the same information, leading to market failure as a good is sold at a higher price/consumed at a lower price

Question 53

How are moral hazards, misinformation and information biases examples of market failure (1.3) (4,4,4)

Answer 53

-A moral hazard occurs when a party may act differently, due to having certain guarantees or promises
-For example, if people have insurance they may act more recklessly
-However, it is difficult to prove people are acting differently
-This can be solved by having bodies to regulate how people are acting, to ensure they are the same

-Misinformation is when consumers are swayed by the wrong information, or completely irrelevant information
-In the Brexit campaign, both sides used likely fake numbers about the NHS and immigration, to get people to vote for them
-However, it is difficult to prove what is correct and what is not
-This can be solved by having third parties informing the population on what is true, what is not and what is/isn’t relevant

-An information bias is when regulators may act favourably to the firms they are regulating
-For example, when regulating a firms finances, regulators may jot the numbers down in specific way, to decrease tax etc
-However, it is very difficult to prove these biases exist
-This can be solved by frequently checking up o the firms and the regulators, to ensure nothing fishy is occurring

Question 54

What are the types of marginal cost, and how to illustrate them (1.3) (3,2)

Answer 54

-Marginal cost is the additional cost of producing one more unit of output
-Marginal private cost is the additional cost to the firm of producing one more unit of output
-Marginal social cost is the additional cost to the third party of producing one more unit of output

-To illustrate this, draw two upwards sloping curves, the lower one being the MPC curve, the upper one being the MSC curve
-The gap between these 2 curves at any point is the external cost

Question 55

What are private costs/benefits, external costs/benefits and social costs/benefits (1.3) (4,4)

Answer 55

-Social cost is the cost of an economic activity to the whole of society
-Private cost is the cost of an economic activity to the individual involved
-External cost is the cost of an economic activity upon the third party
-SC=PC+EC

-Social benefit is the benefit of an economic activity to the whole of society
-Private benefit is the benefit of an economic activity to the individual
-External benefit is the benefit of an economic activity upon the third party
-SB=PB+EB

Question 56

What are tradeable pollution permits, and their pros/cons (1.4) (2,3,2)

Answer 56

-Tradeable pollution permits are when the government sets permits which legally allow firms to produce set amounts of carbon a year, being tradeable since firms can sell and buy these permits
-These are designed to correct negative pollution externalities

-Government caps can ensure pollution is lowered to the level wanted
-May incentivise firms to invest in green tech
-Firms can choose whether to buy more permits, or lower pollution, depending on what benefits them the most

-It is difficult knowing the socially optimum point of pollution (higher pollution or lower output)
-Increased costs will be passed onto the consumer

Question 57

How might supply/demand for tradeable pollution permits change (1.4) (2)

Answer 57

-Over time, the perfectly inelastic supply of tradeable pollution permits will fall, as the government aims to decrease the levels of pollution
-Demand for the permits may rise when the firms want to quickly increase production of pollution, possibly in times of rapid economic growth

Question 58

How do tradeable pollution permits work (1.4) (5)

Answer 58

-Government issues/sells a set amount of permits, representing the amount of pollution they want
-Firms can buy more permits to continue producing at their current level of output
-Firms can decrease pollution output, by selling permits then decreasing output or investing in greener tech
-Either solution will lead to reduced pollution, and depends on what is more profitable for individual firms, and what alternatives to polluting there are
-US sulphur trading scheme reduced sulphur dioxide 40%

Question 59

What is the state provision of public goods, and some pros/cons of doing so (1.4) (2,3,3)

Answer 59

-When a nationalised industry is the main provider of a good/service
-The government can choose to produce merit/public goods, ones underproduced in the free market

-Reduces poverty, since everybody gets access to the same goods/services
-Corrects the market failure by producing the merit goods
-The benefits of the actual spending itself (better healthcare service -> economic growth)

-Heavy opportunity cost of expensive government spending
-Government may produce too much/too little
-Reduced efficiency, the government has less of an incentive to cut costs

Question 60

What are the pros/cons of maximum/minimum prices (1.4) (2,3)

Answer 60

-Can reduce poverty by ensuring everyone has access to necessary goods
-Can help increase/decrease output of goods, to help reach social welfare

-Distortion of price signals leads to excess supply/demand
-Difficult to know where to set the price floors/ceilings due to externalities and excess implications
-Can lead to black markets

Question 61

What are minimum/maximum prices (1.4) (2)

Answer 61

-A minimum price is a legally imposed price above the market equilibrium that suppliers cannot charge below, to disincentivise consumption of a demerit good
-A maximum price is a legally imposed price below the market equilibrium that suppliers cannot charge above, to incentivise consumption of a merit good

Question 62

What are subsidies, and how can they be used to eliminate external cost (1.4) (2)

Answer 62

-Subsidies involve the government paying part of the cost to the firm
-They can eliminate external cost by reducing the price of the good, and should encourage more consumption

Question 63

What are drawbacks of subsidies (1.4) (4)

Answer 63

-Can disincentivise firms to look to cut costs through increasing efficiency
-Opportunity cost of government spending
-It is tough to measure the net welfare loss to society, and therefore how big the subsidy should be
-If a good has inelastic demand, the subsidy would have to be large enough to have the desired effect

Question 64

What is government failure + examples (1.4) (1,2,2,2,2)

Answer 64

-Government failure is when government intervention in the market leads to net welfare losses and a misallocation of resources

Distortion of price signals
-Government intervention can distort free market signals
-Min/Max prices can create excess supply/demand, and lead to inefficient prices

Unintended consequences
-Consumers and firms can react unexpectedly
-NHS targets for treating patients unintentionally decreased the quality of care

Excessive costs
-A lot of government allocated money is used up on basic administration costs
-A lot of NHS money is spent on organisational administration, rather than care

Information gaps
-Costs & benefit forecasts of investment are often wrong
-It is impossible to gain ‘perfect’ data, so government information will be limited

Question 65

What are the pros/cons of provision of information and regulation (1.4) (3,2,3,2)

Answer 65

-When there’s asymmetric information, the government can provide information
-This helps consumers to act rationally, allowing the market to work properly
-These can be used alongside other policies

-Provision of information can be expensive, incurring an opportunity cost
-Due to irrational behaviour, consumers may not listen to provided information

-Governments are able to impose laws/caps to ensure firms follow regulation
-Ensures consideration of externalities, maximising social welfare
-UK regulation includes: EU fishing quotas, smoking bans, minimum wages/ages

-Laws may be expensive, incurring opportunity cost
-Firms may pass on costs, and costs may differ

Question 66

What are indirect taxes, how can they eliminate external costs and what are the pros/cons of indirect taxes (1.4) (2,2,3)

Answer 66

-An indirect tax is a tax on spending, paid by the producer
-Taxes on negative externalities are intended to reduce consumption and create a more socially efficient outcome

-Indirect taxes internalise the externality, as the market now produces at the socially optimum level
-Taxes raise government revenue

-If demand is inelastic, the taxes may not be successful
-It is difficult to estimate the correct size of the externality, and thus the tax
-Indirect taxes are regressive, harming the poor more than the rich