Theme 1 - Introduction to Markets and Market Failure (1.4 - Government Intervention)

Question 1

What is the purpose of government intervention? [1]

Ref - 1.4.1 - Government Intervention

Answer 1

To correct any present market failure in an economy. [1]

Question 2

State and describe 2 types of indirect tax. [4]

Ref - 1.4.1 - Government Intervention

Answer 2

Unit tax [1] - A levy set on a good/service at a constant amount per item. [1]

Ad Valorem tax [1] - A levy set on a good/service set as a % of a price (e.g. VAT) [1]

Question 3

How would taxation work to solve market failure in an economy? [4]

Ref - 1.4.1 - Government Intervention

Answer 3

Setting tax = to the negative production externality [1] would cause increases in CoP, so MPC shifts inwards [1], forcing producers to produce at the social optimum [1] where there is lower demand for demerit goods, so production falls. [1]

Question 4

Explain why indirect taxation may not solve market failure. [2]

Ref - 1.4.1 - Government Intervention

Answer 4

• If consumer good is inelastic, consumers may still accept higher price of Pe2 [1] so production of demerit goods continues, therefore negative production externality remains. [1]

Question 5

What is a subsidy? [1]

Ref - 1.4.1 - Government Intervention

Answer 5

Money from the government to a producer to encourage production + reduce price of goods. [1]

Question 6

How would the distribution of subsidies work to solve market failure? [4]

Ref - 1.4.1 - Government Intervention

Answer 6

Subsidising goods will increase quantity and reduce cost [1] so supply will shift inwards to the right. [1] This means that the good may be consumed more, [1] therefore increasing the external benefits associated with that good. [1]

Question 7

On a S&D diagram, how does a subsidy work to reduce market failure? [2]

Ref - 1.4.1 - Government Intervention

1

Answer 7

(Ref - Figure 1 Page 30)
- Price of a good decreases to (Z) [1]
- Producers are incentivized to increase production by a subsidy, shown by Q1 to Q2 [1]

Question 8

Describe 2 advantages of subsidies in solving market failure. [4]

Ref - 1.4.1 - Government Intervention

Answer 8

• Increased consumption of goods with external benefits [1] works to solve market failure. [1]
• Subsidies improve purchasing power for those on low incomes [1] as goods with external benefits have lower prices. [1]

Question 9

What is a Tradeable Pollution Permit? [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 9

A permit which limits the amount of carbon emissions in relation to the amount of permits a firm has. [1]

Question 10

How do tradable pollution permits work to solve market failure? [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 10

• Total number of permits available determine the level of pollution the government wants (e.g. social optimum). [1]
• Permits are tradable between firms, who may sell them to firms who pollute more. [1]

Question 11

On an externality diagram, explain how permits work to solve market failure. [3]

Ref - 1.4.1 - Government Intervention in Markets

Answer 11

• Permits create a social optimum at Q* [1]
• Therefore quantity of pollution is limited to the social optimum at Q* [1]
• So firms costs will rise to Pe2 as a result [1]

(Page 31 - Diagram)

Question 12

Explain why tradable pollution permits may not solve market failure. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 12

• Heavy polluting firms can push costs to consumers if demand is inelastic for their goods, [1] allowing them to pollute more by buying more permits. [1]

Question 13

What is a regulation? [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 13

Rules, laws, and restrictions imposed by the government. [1]

Question 14

State 2 types of regulation. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 14

• Quotas [1]
• Bans [1]

Question 15

Describe how quotas work to solve market failure, and give an example of a quota. [3]

Ref - 1.4.1 - Government Intervention in Markets

Answer 15

• A quota is a limit put in place by the government. [1]
• This can reduce any external costs/overproduction of a good/service. [1]
• e.g. quotas put on fishing to reduce over-fishing. [1]

Question 16

Explain why regulations may not solve market failure. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 16

Large amounts of corruption e.g. bribery [1] can mean that quotas are bypassed, so negative externalities continue to be overproduced. [1]

Question 17

What is meant by the Provision of Information? [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 17

Information provided to an uninformed party to allow rational decisions. [1]

Question 18

Describe 2 examples of information being provided to an uninformed party. [4]

Ref - 1.4.1 - Government Intervention in Markets

Answer 18

Health Campaigns [1] - e.g. informing the public about the dangers of smoking through advertisments and posters. [1]

Information on sale [1] - e.g. the amount of calories a food contains is stated clearly on the label for the consumer. [1]

Question 19

Explain why the provision of information may not solve market failure. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 19

• Information may be ignored if the demerit good is inelastic [1] causing the continued consumption of demerit goods. [1]

Question 20

State and describe 2 policies to tackle Geographic immobility [4]

Ref - 1.4.1 - Government Intervention in Markets

Answer 20

1. Relocation subsidies [1] - reduces the cost of moving areas, e.g. by contributing to house removal cost, rental costs etc. [1]
2. Increasing affordable housing [1] - providing subsidies to homebuilders to incentivise more affordable housing being built. [1]

Question 21

Describe 1 possible limitations of the policies to tackle geographic immobility. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 21

1. Opportunity costs [1], as governments may need to cut funding elsewhere in the economy. [1].

Question 22

State and describe 1 policy to improve occupational mobility. [3]

Ref - 1.4.1 - Government Intervention in Markets

Answer 22

• Subsidizing education and skills training. [1].
• Labour can earn transferrable skills easier. [1]
• Therefore have a higher chance of gaining jobs in other sectors. [1]

Question 23

State a limitation to the policy of improving occupational mobility. [3]

Ref - 1.4.1 - Government Intervention in Markets

Answer 23

• Time Lag [1] - as workers take time to train, they cannot work/contribute [1], therefore workers are occupationally immobile for a short time period. [1]

Question 24

What is meant by the maximum price? [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 24

Price set by the government which a good/service cannot rise above. [1]

Question 25

Give an example of where maximum price schemes can be implemented. [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 25

Setting a maximum price on water in order to prevent exploitation of consumers by companies. [1]

Question 26

Describe how a maximum price would be implemented on a Supply and Demand diagram. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 26

• Maximum price is drawn as a straight line [1]
• below the price equilibrium P1 [1]

Ref - Page 38 (Diagram)

Question 27

What is the effect of a maximum price shown on a S&D diagram? [4]

Ref - 1.4.1 - Government Intervention in Markets

Answer 27

• Maximum price causes a expansion in demand and contraction in supply [1]
• Therefore, there is excess demand in the area Q1Q2. [1]
• Suggesting that more consumers are able and willing to buy the cheaper goods. [1]
• and suppliers are less willing to supply the good at the max price. [1]

Ref - Page 38 (Diagram)

Question 28

Give 2 factors which can impact the excess demand caused by the maximum price. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 28

• The extent of the PED/PES [1]
• Magnitude of the maximum price. [1]

Question 29

Explain why maximum price schemes may not solve market failure. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 29

(Magnitude argument) If maximum price set too high, the reduction in price is not as high [1] so the effect of the max price on demand is reduced. [1]

Question 30

What is meant by a minimum price? [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 30

Price set by the government which a good/service cannot fall below. [1]

Question 31

Give an example of minimum prices being implemented [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 31

Minimum prices on alcohol to attempt to reduce consumption, and external costs. [1]

Question 32

Describe how a minimum price would be implemented on a S&D diagram. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 32

• Minimum price is a straight line [1]
• located above the price equilibrium. [1]

Question 33

What is the effect of a minimum price, shown on an S&D diagram? [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 33

• Causes an expansion in supply, and contraction in demand. [1]
• therefore, there is excess supply (AB) [1]

Ref - Page 40 (Diagram)

Question 34

How can Guaranteed Minimum Prices be represented on a diagram? [3]

Ref - 1.4.1 - Government Intervention in Markets

Answer 34

• Governments buy up excess supply when setting minimum prices. [1]
• Excess supply shown by (ABQ3Q2) [1]
• Total producer income is guaranteed at (P2BQ3O) [1]

Ref - Page 41 (Diagram)

Question 35

Give 2 advantages of minimum prices [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 35

• Higher prices for demerit goods reduce external costs. [1]
• Minimum prices solve market failure of unstable commodities. [1]

Question 36

Give 2 disadvantage of minimum prices. [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 36

• Higher prices reduces consumer surplus and welfare. [1]
• Opportunity cost as governments buying up excess supply, so reduces spending in other areas of economy. [1]

Question 37

What is a buffer stock scheme? [1]

Ref - 1.4.1 - Government Intervention in Markets

Answer 37

• Buying/selling commodities to reduce price fluctuations to meet a target price. [1]

Question 38

Describe how buffer stock schemes work to solve market failure. [4]

Ref - 1.4.1 - Government Intervention in Markets

Answer 38

• Government sets a target price, and a max+min price. [1]
• This allows the commodity to only fluctuate in this band. [1]
• If prices get too low, the government buys the commodity. [1]
• If prices get too high, the government sells the commodity. [1]

Question 39

Explain how buffer stock schemes are represented on a S&D diagram, considering that supply of a good has increased over time. [4]

Ref - 1.4.1 - Government Intervention in Markets

Answer 39

• If supply has shifted outwards to S2 [1]
• governments will buy up the excess commodities. [1]
• Therefore shifting demand outwards to D2 [1]
• Therefore remaining near target price. [1]

Question 40

Explain why buffer stock schemes may not solve market failure [2]

Ref - 1.4.1 - Government Intervention in Markets

Answer 40

Setting of incorrect price ranges due to imperfect information [1] can mean that the ranges can be too unrealistic, so stock prices may continue to fluctuate. [1]

Question 41

Describe what is meant by government failure. [2]

Ref - 1.4.2 - Government Failure

Answer 41

• Governments acting to deal with market failure [1] but creating further failure and net welfare losses. [1]

Question 42

State 4 causes of government failure. [4]

Ref - 1.4.1 - Government Intervention in Markets

Answer 42

• Unintented Consequences [1]
• Information Gaps [1]
• Excessive Administration Costs [1]
• (Distortion of Price Signals) [1]

Question 43

Explain how unintended consequences can causes government failure, using an example. [3]

Ref - 1.4.2 - Government Failure

Answer 43

• e.g. Imposing a minimum price on cigarettes may reduce their purchase [1]
• Smokers may then continue to smoke on secondary markets (e.g. black markets) [1]
• so therefore crime and smuggling increases, which is unintended. [1]

Question 44

Explain how excessive administration costs can cause government failure, with an example.[2]

Ref - 1.4.2 - Government Failure

Answer 44

• Government intervention, such as improving the NHS, is very costly [1]
• so social benefits may be outweighed by the administrative costs. [1]

Question 45

Explain how the distortion of price signals can cause market failure, using the housing market as an example. [3]

Ref - 1.4.2 - Government Failure

Answer 45

• e.g. Maximum prices on properties incentivises landlords to remove properties. [1]
• as they make less revenue on them [1]
• therefore causing a shortage of rental properties, impacting consumer welfare. [1]

Question 46

State 3 examples of markets where government failure can occur. [2]

Ref - 1.4.2 - Government Failure

Answer 46

• Labour Markets [1]
• Housing Markets [1]
• Transport [1]