Theme 1: Introduction to markets and market failure Flashcards
1.1.1a
Why economists (systems) exist
Devise methods
of allocating scarce resources
AS
society cannot have everything it wants
1.1.1b
Define Ceteris Paribus
Keeping one variable the same and changing the others
1.1.1c
Why can’t we make scientific experiments in Economics?
Variables are constantly changing
THUS
results will always different
AND
not be accurate or precise
SO
assumptions are made
1.1.2a
Positive Economic Statements
- Objective + fact-based
- tested + validated against real-world data
- A Statement that is verifiable by data
1.1.2a
Normative Economic Statements
- subjective + value-based
- express judgments
- a statement that involves a value judgement
1.1.2b
Role of Value Judgements
- positive statements used to back up normative statements
- influence policy makers (govts) + decision making
1.1.3a
Problem of Scarcity
Economic Resources = scarce
as ∞ wants+ needs of ppl/businesses in economy
THUS
important to efficiently use resources to max output
1.1.3a
Labour
Human input into production process
Recent years = sustained expansion in employed labour force
Housewife etc = not labour as productions non-marketed output > not included in GDP
⬆️Q labour = ⬆️education + training + experience
Productivity = output per worker over given period of time
Human capital = quality of labour resources
⬆️ HC = ⬆️investment in education +training + health
1.1.3a
Land
Natural resource available for production
Some nations endowed with/ NR
THUS
exploit by specialising in extraction/production of resources
E.G North Sea oil/gas
ONLY free = air
AS
consumption by one person doesn’t reduce air for others
Free good = no opportunity cost
1.1.3a
Capital
Finance required to operate a business
Investment in goods that can produce other goods in future
E.g = machines , roads , factories , schools
⬆️Capital stock = ⬆️ investment = important in long run
AS
W/o capital , economy cannot produce output ∴ full capacity reached quickly
1.1.3a
Enterprise
Ppl who organise / co-ordinate FOP
Specialist labour input
⬆️ Q E = ⬆️ successful business
1.1.3b
Renewable Resources
Can be replaced e.g fish stock
Generation of power from wind , solar
1.1.3b
Non-Renewable Resources
Once used will never be replaced
If used today cannot be available for our children , children’s children etc
1.1.3c
Define Opportunity Cost
value of the next best alternative which has been sacrificed
State the Economic Agents
Consumers
Producers
Governments
1.1.3c
Importance of Opportunity Cost to Consumers
- Helps C make informed decisions by comparing benefits of different spending options
- Guides budget allocation, ensuring money is spent where it provides the most satisfaction as C don’t have unlimited budget
- Maximises utility by evaluating the trade-offs between various consumption choices.
1.1.3c
Importance of Opportunity Cost to Producers
- Aids in resource allocation to maximise profit or efficiency across production activities
- Informs production decisions by comparing the potential returns from different product lines
- Supports profit maximisation through optimal use of resources based on opportunity costs
1.1.3c
Importance of Opportunity Cost to Governments
- Informs policy-making by evaluating trade-offs in public spending and investment priorities
- Guides budgetary decisions to allocate funds where they yield the greatest societal benefits
- Ensures efficient resource allocation across various sectors, balancing societal needs and objectives
1.1.4a
Define PPF
A curve that illustrates the various combinations of two goods or services that an economy can produce when all resources are fully and efficiently utilised, given the state of technology
1.1.4a
Depictions of a PPF
- the PPF line represents maximum productive potential of an economy
- opportunity cost is when producing more of one good means producing less of another good, steeper the line = more OC
- economic growth = outward shift due to increase in FOP
- economic decline = inward shift due to depletion in resources (natural disaster , war = less labour)
- efficient allocation means point is on curve
- inefficient allocation means point is inside curve leading to leading to underemployment or misallocation
- possible means the economy can produce the combination of goods
- unobtainable means point is outside PPF , economy cannot produce it unless economic growth
1.1.4c
Define Capital Goods
assets used in the production of other goods and services
1.1.4c
Define Consumer Goods
purchased by individuals or households for personal use or consumption. They satisfy immediate wants and needs.
1.1.5a
Define Specialisation
individuals, firms, or nations focus on producing a limited range of goods or services. By concentrating on specific tasks or products, they become more efficient and proficient.
1.1.5a
Adam Smith and Specialisation
- higher efficiency = quicker
- enhanced production = more efficient
- economies of scale = fixed costs spread of larger G+S
1.1.5a
Define Division of Labour
breakdown of production processes into smaller, specialised tasks, with each worker or group focusing on a specific part of the process
1.1.5a
Adam Smith and Division of Labour
- improved efficiency as worker skilled at specific task
- increased output
- innovation as workers = experts + can find new ways
1.1.5b
Advantages of Specialisation and DoL in organising production
- increased productivity due to focus on specific tasks
- improving skills = higher quality products
- time saving
- Innovation and Technological Progress as workers and firms seek to improve their specific areas of production
- economies of scale
1.1.5b
Disadvantages of Specialisation and DoL in organising production
- Boredom and Decreased Motivation due to repetitiveness = lower job satisfaction
- Overdependence on Specific Workers or Processes
- Lack of Flexibility as firms cannot product different product
- Potential for Inefficiencies if once stage lacks efficiency
- Vulnerability to Economic Changes as if only focus on one product , won’t be good due to market/tech change
1.1.5c
The Advantages of Specialising in the Production of Goods and Services to Trade
- Increased Efficiency and Comparative Advantage as countries do what they are best at
- Economies of Scale means more competitive globally
- Higher Quality and Innovation if focussing on specific industry
- Expanded Trade and Market Access as can give away excess products for what it doesn’t have
- Economic Growth and Development
1.1.5c
The Disadvantages of Specialising in the Production of Goods and Services to Trade
- overdependence on Specific Industries = vulnerable to market fluctuations, trade restrictions, or technological changes
- exposure to global economic shock
- Resource Depletion and Environmental Impact due to intensive specialisation
- Loss of Domestic Diversity and Resilience = decline of other industries
1.1.5d
Function of Money : Medium of Exchange
- Money acts as an intermediary in the exchange of goods and service
- in a barter system , a double coincidence is needed to trade
1.1.5d
Function of Money : Measure of Value
Money provides a common standard for measuring and comparing the value of goods and services, allowing for the setting of prices
1.1.5d
Function of Money : Store of Value
- Money allows individuals to store wealth over time, maintaining its value for future use
- unlike perishable goods , money doesn’t degrade over time
1.1.5d
Function of Money : Method of deferred payment
Money enables the settlement of debts at a future date, allowing for contracts and credit arrangements
1.1.6a
Free Market Economies
- economic decisions are driven by the forces of supply and demand with minimal government intervention
- FoP owned privately
- prices determined by competition
- Adam Smith claimed there was an ‘invisible hand’ in which individuals seeking their own self-interest would unintentionally contribute to economic prosperity
1.1.6b
Advantages of Free Market Economies
- efficiency as businesses allocate resources efficiently as per to demand
- competition drives innovation + improvement
- wide consumer variety/choice
1.1.6b
Disadvantages of Free Market Economies
- inequality as wealth concentrated in hands of few
- market failure of public goods as they can be underprovided due to lack of incentive to create them
- externalities e.g pollution may be ignored
1.1.6a
Mixed Economies
- private sector drives most economic activities, the government regulates and intervenes in areas where the market might fail or to achieve broader social objectives
- Fredrich Hayek claimed excessive central planning might lead to inefficiency and loss of individual freedoms
1.1.6b
Advantages of Mixed Economies
- combines efficiency of markets with social welfare
- govt can intervene to correct market failure + address social inequalities
- ensures production of public goods
1.1.6b
Disadvantages of Mixed Economies
- govt intervention can lead to inefficiencies + bureaucracy
- can lead to conflict + political disagreements
1.1.6a
Command Economies
- government makes all economic decisions, controls the factors of production, and plans the allocation of resources
- state determines what to produce, how to produce it, and who receives the output
- Karl Marx supports socialist system to plan + distribute resources to ensure equality
1.1.6b
Advantages of Command Economies
- equality as wealth distributed evenly
- stability as central planning prevents economic fluctuations e.g unemployment
1.1.6b
Disadvantages of Command Economies
- inefficiency due to lack of competition and profit motive
- lack of freedom
- no innovation
1.1.6c
Role of the state in Mixed Economies
- market regulation e.g to enforce laws + protect C from exploitation + prevent monopolies
- Financial Oversight e.g to maintain stability + prevent crisis
- Provide public + merit goods
- social welfare programs to redistribute incomes and reduce inequality e.g unemployment benefit
1.2.1a
Rational Economic Decision Making
Consumers aim to maximise utility:
- act rationally to find best way to maximise utility (weigh pros/cons)
Firms aim to maximise profits
1.2.1a
Define Utility
satisfaction or pleasure that consumers derive from consuming goods and services
1.2.2a
Movements along a Demand Curve
- decrease in price = increase in quantity (expansion)
- increase in price = decrease in quantity (contraction)
1.2.2b
Shifts along a Demand Curve
PIRATES
1) 🔺Population
2) 🔺Income
3) 🔺Related goods
4)Ads
5) 🔺 trend/fashion
6)Expectations : expectation of shortages for a good / ⬆️price rise in future = ⬆️D
7)Seasons
8) 🔺govt legislation e.g kids car seats
1.2.2c
Diminishing Marginal Utility
Satisfaction gained (utility)
diminishing
per additional unit (marginal)
of good consumed
1.2.2c
Demand Curve influenced by Diminishing Marginal Utility
Sloped down as each additional unit provides less utility so at
- higher prices less are bought as consumers aren’t willing to pay high prices for less utility
- lower prices more are bought as the lower price justifies getting less utility per unit.
1.2.3a
Define Price Elasticity of Demand (PED)
Measures the responsiveness of quantity demanded to a change in price, holding other factors constant
1.2.3b
Formula for PED
%🔺QD
______________
% 🔺Price
Always negative
1.2.3c
Numerical Values for PED
Unitary elastic: PED = 1
Perfectly elastic: PED = ∞
Relatively elastic: PED > 1
Relatively inelastic: 0 < PED < 1
Perfectly inelastic: PED = 0
1.2.3a
Define Income Elasticity of Demand (YED)
Measures the responsiveness of quantity demanded to a change in income, holding other factors constant
1.2.3d
Factors influencing PED
1)Necessity - if you need something, curve = inelastic
2)Availability of Substitutes - lots of subs, curve = elastic
3)Proportion of income - small % of expenditure , curve = inelastic
4)Time - longer time = easier to find alt , curve = elastic
5)Addictive - more addictive, curve = inelastic
6)Switching costs e.g phone contracts incur costs when changing
1.2.3b
Formula for YED
%🔺QD
——————-
% 🔺income
1.2.3c
Numerical Values for YED
Inferior Good: YED < 0
Normal Good: YED > 0
Luxury Good: YED > 1
>1 = elastic
<1 = inelastic = necessity
1.2.3a
Define Cross Elasticity of Demand (XED)
Measures the responsiveness of quantity demanded of one good to a change in the price of another good, holding other factors constant
1.2.3b
Formula for XED
%🔺Qd in Good x
——————————-
%🔺price in Good Y
1.2.3c
Numerical Values for XED
Substitute goods: XED > 0
Complementary goods: XED < 0
Unrelated goods: XED ≈ 0
stronger relationship = higher number
1.2.3e
Significance of elasticities of demand to firms and govt
1.2.3f
relationship between PED and total revenue
- Elastic (PED > 1): decrease in price = proportionally larger increase in quantity demanded = increase in total revenue
- Inelastic (PED < 1): decrease in price = proportionally smaller increase in quantity = decrease in total revenue
- Unit elastic (PED = 1): change in price = equal percentage change in quantity demanded = no change in total revenue
1.2.4a
Movements along a supply curve
- higher price = increase in quantity (expansion)
- lower price = decrease in quantity (contraction)
1.2.4b
Shifts along a supply curve
- cost of production
- production of other goods
- weather
- technology
- goals of supplier
- govt legislation
- tax + subsidies
-
1.2.4b
Reasons why supply curve slopes up
- higher prices means higher profit so firms supply more to sell
- higher prices means new firms enter market to make more profit and increase supply
- more supply = rising marginal cost but can be justified by increasing profits
1.2.5a
Define Price Elasticity of Supply
responsiveness of quantity supplied to a change in
price, holding other factors constant
1.2.5b
PES formula
%🔺Q supplied
———————
%🔺price
1.2.5c
Numerical Values of PES
Perfectly elastic: PES = ∞ (Producers are willing to supply any quantity at a given price)
Relatively elastic: PES > 1
Unit elastic: PES = 1
Relatively inelastic: 0 < PES < 1
Perfectly inelastic: PES = 0 (Quantity supplied remains constant regardless of price changes)
1.2.5d
Factors influencing PES
- time : short term where 1 FOP is fixed ∴firms can’t respond quickly to price changes
- production time e.g agricultural good take long to make
- spare capacity e.g can hold more stock ∴ ⬆️versatile to change
- spare capacity e.g machines
- FOP readily available?
- factor immobility e.g transport between counties for capital goods
- ability to switch production
1.2.5e
Short run PES
atleast one FOP is fixed
1.2.5e
Long run PES
all FOP are variable
1.2.7a
Define Price Mechanism
Adam Smith : ‘invisible hand of price mechanism’
Little govt intervention will benefit economy
C/P decisions interact to determine scarce resource allocations between competing uses
Ensures equilibrium met in free market
1.2.7a
Rationing Function
Extension/contraction in D (brought about by supply shift)
Price rations scarce resources when D>S ∴only those willing/able to pay can purchase G/S
E.g ⬇️S = ⬆️D
Rationing function clears market of consumers not will/able to pay
E.G Auctions where price⬆️ till one buyer left them D=S
1.2.7a
Incentive Function
Incentive motivates C/P to 🔺behaviour
Extension/contraction in S (brought about by D shift)
C choices send info to P about dynamic wants/needs
⬆️D = ⬆️Prices = incentive to ⬆️output (extension) as ⬆️profit for supplier
⬇️D e/g recession = supply contracts as producers ⬇️output
1.2.7a
Signalling Function
Shift in D/S
⬆️prices = signal to C to ⬇️D or withdraw market + potential P enter market
⬇️prices = C enter market + P leave market
1.2.7b
Price Mechanism in Local Markets
- smaller scale
- more sensitive to price changes due to limited options
- local tastes, preferences, and income levels can significantly influence prices
1.2.7b
Price Mechanism in National Markets
- larger scale
- more intensive price competition due to more competitors
- National economic conditions, government policies, and consumer trends can influence prices
1.2.7b
Price Mechanism in Global Markets
- international market
- trade barriers + exchange rate affect prices
1.2.8a
Consumer Surplus
- difference between price willing and actual
Willingness = demand
Actual = market
1.2.8a
Producer Surplus
- difference between minimum price producers willing to accept and able to accept
Willingness = supply
Able = market price
1.2.8a
Society Surplus
Consumer surplus + producer surplus
Beneficial
1.2.8b
Diagrams for surplus
consumer surplus on top
producer surplus bottom
1.2.8c
Changes in S and D affecting surplus
- increase D = both increase
- decrease D = both decrease
- increase S = increase in C + decrease in P
- decrease in S = increase in P + Decrease in C
1.2.9a
Define Tax
Compulsory charge levied by the government
1.2.9a
Define Indirect Tax
tax collected through an intermediary
1.2.9a
Typed of Indirect Tax
- Ad Valorem
- Specific
1.2.9a
Ad Valorem Tax
Tax placed on each good is percentage based thus more expensive good has higher tax
1.2.9a
Specific Tax
tax placed on each good is same regardless of price
1.2.9a
Impact of Indirect Tax on C,P and govt
- increases prices of G for C
- reduce profits for P as higher cost of production
- generate revenue for govt
1.2.9a
Incidences of indirect taxes
- consumer incidence on top
- producer incidence bottom
1.2.9a
Inelastic demand curve on taxation
Large consumer incidence
Small producer incidence
1.2.9a
Elastic demand curve on taxation
Small consumer incidence
Large producer incidence
1.2.9a
Evaluating Tax
- regressive tax : income not take into account thus poor ppl spend larger proportion of it on tax = increasing inequality. Problem exasperated if PED=in elastic + consumer tax incidence greater
- unintended consequences : tax meant to reduce consumption but often will lead to switch to harmful substitutes thus solution = substitute taxed too
- PED inelastic : large price increase = small demand increase (diagram) thus only effective is large enough
- Laffer curve : if tax = too high > revenue will fall as other options seemed out e.g smuggling = other problems
1.2.9a
Define Subsidy
- Grants implement by the government in order to lower the price and increase supply .
- received by producer but some passed to consumer + some absorbed by producer
1.2.9a
Impact of Subsidy on C,P and govt
- reduce price of G for C
- increase profits for P
- require govts to spend money, financed from taxes
1.2.9a
C and P subsidy
- producer gain on top
- consumer gain bottom
1.2.9a
Inelastic demand curve on subsidy CHECK
Large producer incidence
Small consumer incidence
1.2.9a
Elastic demand curve on subsidy CHECK
small producer incidence
large consumer incidence
1.2.10a
Reasons why consumers won’t behave rationally
- influence of other people’s behaviours
- importance of habitual behaviour
- consumer weakness at computation
1.2.10a
Consumers ≠ rational
Influence of other’s behaviour
- individuals don’t make independent choices
- decide based on social norms
- herding behaviour = beliefs on how to behave
1.2.10a
Consumers ≠ rational
Habitual behaviour
- short cuts in decision making
- e.g rule of thumb = quick but not accurate
- Heuristic behaviour = mental short cuts
- C don’t gather all info necessary for good decision as not time/effort worthy
- e.g supermarkets put ⬆️profit G at eye level as ppl more likely to to buy these
1.2.10a
Consumers ≠ rational
Weakness at computation
- C cannot do maths to compare prices ∴firms exploit this but giving info disjointed or not enough
- bounded rationally = C who make decisions based on analysing all info they have
1.3.1a
Define Market Failure
Market forces fail to allocate resources efficiently enough to.g some markets fail to supply quantity demanded but consumers
1.3.1b
Types of Market Failure
- externalities
- under provision of public goods
- information gaps
1.3.2a
Define Externality
Third part effects arising from production and consumption of goods and services for which no appropriate compensation is paid
1.3.2a
Define Private Costs
direct costs incurred by an individual or firm in producing or consuming a good or service
1.3.2a
Define External Costs
costs imposed on third parties who are not directly involved in the production or consumption of a good or service
1.3.2a
Define Social Costs
total costs to society, including both private costs and external costs
1.3.2a
Externality Cost calculation
Social cost = Private cost + External cost
1.3.2b
Define Private Benefit
direct benefits that an individual or firm receives from producing or consuming a good or service
1.3.2b
Define External Benefit
benefits that accrue to third parties who are not directly involved in the production or consumption of a good or service
1.3.2b
Define Social Benefit
Total benefits to society, including both private benefits and external benefits
1.3.2b
Externality Benefit calculation
Social benefit = Private benefit + External benefit
1.3.2b
Define Merit Goods
good with external benefits, where the benefit to society is greater than the benefit to the individual
1.3.2b
Define demerit Goods
good with external costs, where the cost to society is greater than the cost to the individual
1.3.2c
Negative Externalities
Social costs > private cost (only production)
Caused by ⬆️in P/C by one unit
1.3.2d
Positive externalities
Social benefit > public benefit
Merit good under consumer as free market fail to value them correctly
1.3.2e
Impact of Externalities on Consumers
- negative externalities reduce well being + quality of life (pollution)
- positive externalities benefit them (education)
- Government intervention can help to mitigate the negative effects of externalities and enhance the positive effects
1.3.2e
Impact of Externalities on Producers
- producers face extra costs due to negative externalities (pay for pollution)
- benefit from positive externality (increased productivity)
- govt intervention can effect costs and revenue of firm
1.3.2e
Impact of Externalities on Government
- negative externality means govt has to spend more resources to reduce them
- positive externality benefits govt as economic growth
- govt can intervene through taxes , subsidies etc
1.3.2e
Externality EV
We never know what Q* is exactly thus hard got govt to intervene as don’t know how much they need to intervene > info gaps
1.3.2e
Production externality
Generated in supplying G/S e.g noise from transportation
1.3.3a
Define Non-rivalry Goods
Consumption of a good by one person does not reduce its availability for consumption by others
1.3.3a
Define Non-excludability Goods
difficult or impossible to prevent individuals from consuming the good, even if they have not paid for it
1.3.3a
Define Public Goods
- both non-rivalry and non-excludability.
- leads to market failure as private firms can’t profit from providing public goods
1.3.3a
Define private Goods
- either rival or excludable, or both
- provided by market as profit can be made
1.3.3b
Free rider problem
Consumers can benefit from public goods without paying creating a disincentive for firms to provide/supply it
1.3.4a
Define Symmetric Information
all parties involved in a transaction have access to the same information
1.3.4a
Define Asymmetric Information
one party in a transaction has more information than the other party
1.3.4b
Imperfect Market Allocation leading to misallocation
Producer need to know info to allocate resources efficiently
Consumers need to know info to purchase goods w/ most utility
Sometime p and c know diff info e.g P know house as damp roof but c doesn’t thus pays full house price
1.4.1a
Purpose of Govt intervention
address market failure
1.4.1a
State Government Interventions
1) Indirect Taxation
2) Subsidies
3) Max/Min prices
4) Trade Pollution Permits
5) State Provision of Public Goods
6) Provision of Information
7) Regulation
1.4.1a
Government Intervention : Indirect Taxation + Subsidies
+deal directly w/ externality
+adjustable according to problem size
+shift MPC left
-difficult identifying Q* and external cost
-indirect taxes = regressive as ⬆️poor ppl income goes to tax= market failure
-PEDe.g if inelastic then ⬆️tax but still ⬆️D change
1.4.1a
Government Intervention : Subsidies
1.4.1a
Government Intervention : Min prices
When equilibrium = too low
Govt intervene to set artificial min price that sellers can sell
Aka price floor
This is done to protect firms in key industries e.g agriculture that are volatile to price changes (primary sector)
E.g industries w/ ⬆️employment have min as to avoid bankruptcy and ∴⬆️unemployment
E.g imported goods as to avoid firms exiting market as costs>profit
1.4.1a
Government Intervention : Min prices EV
When price cannot revert to natural equilibrium then S>D ∴ surplus = problem and govt have to purchase these surplus to above firm ceasing production and ⬆️price= ⬇️demand
This created firm dependency on govt ∴ continue producing surplus ∴allocatively inefficient
Rationing/incentive function cannot operate and ⬇️price = extension demand + supply contraction
1.4.1a
Government Intervention : Max prices
Price ceiling = market price too⬆️ this govt ⬇️
Reason = ⬆️prices ration goods so that D=S ∴ some C excluded form market as cannot afford goods e.g medicine
1.4.1a
Government Intervention : Max prices EV
Rationing + incentive function cannot operate
Ceiling = ⬆️attractive to consumers then producers ∴ shortage
As
⬇️prices = ⬇️profit ∴ no incentive to produce goods
BUT
⬆️D (rationing function)
= serious problem as max prices usually for necessities
1.4.1b
Government Intervention : Trade Pollution Permits
+give firms incentive to ⬇️pollution
+permits can be sold
+encourage firms to lower pollution below permit
-relies of the fact that external cost can be measures
-high admin costs w/ constant monitoring
-high polluting countries can buy permits from low polluting countries thus don’t need to reduce pollution
-developing countries excluded from permits but given credits for ‘certified reductions’
1.4.1b
Government Intervention : Trade Pollution Permits App
1 permit = 1 tonne CO2
N.o of permits in circulation ⬇️ over time
If country ⬆️ more CO2 then allowed they:
1) purchase ⬆️ permits
2)invest in ⬇️ CO2
3) invest in developing country = ⬆️ carbon units for them
But they all ⬆️ costs of production thus MPC MOVE LEFT
1.4.1b
Government Intervention : Trade Pollution Permits EV
- n.o of permits not always set correctly due to info gaps of UN/EU thus ⬆️permits = cheap to buy/sell so no firm incentive
- stockpiling during recession as ⬇️CO2 = permits used in future e.g Covid 2019
- China + USA = top 2 contributors 27/11% respectively aren’t involved
- unless strict regulations , firms can pollute as much as they want as cheaper to bride rather than decrease CO2
- Q* = hard to set and might be hard to meet
- no funds go from polluting firms to members of society dealing with problems caused by
1.4.1b
Government Intervention : State Provision of Public Goods
Govt produced G/S mainly necessity
+govt has full control over quantity + price
+directly provide market w/ Q*
+bring consumers into market who typically can’t afford
-expensive
-info gaps so price+quantity hard to set
-govt knows to be inefficient e.g prices>if private sector did it
-privatisation
- reduced competition but ⬇️quantity + ⬆️prices
-leads to command economy EV
-EV lag time
1.4.1b
Government Intervention : Provision of Information
Pass law that suppliers cannot exclude info gaps or place warning on G/S
+suppports firms/conusmers in rational decision making
+⬆️D = ⬆️MSB = closer to Q*
-can be ignored e.g ads
-⬆️costs for businesses
-⬆️govt expenditure to enforce these
1.4.1b
Government Intervention : Regulation
laws set to reduce negative externalities e.g outdoor smoking
can place restriction or completely prohibit
+ individual circumstances can be analysed thus appropriate action can be taken
+easily understood but firms
-inspectors need to be employed at a cost
-investigations = expensive
-external cost needs to be measurable + quantifiable
-fine>cost so firm have incentive to stop
1.4.2a
Cause of Government Failure
government intervention in the economy leads to a net welfare loss
1.4.2b
Cause of Govt Failure
- Distortion of Price Signals
- Unintended Consequences
- Excessive Administrative costs
- Information Gaps
1.4.2b
Cause of Govt Failure - Distortion of Price Signals
- intervention will disrupt price mechanism
- market failure = more serious market failure e.g subsidies = cheap prices = cheaper exports = foreign markets not competitive
- minimum wage = unemployment
- planning permission/ green belts decreases elasticity of housing market thus demand outstrips supply
- more subsidies= less incentive to be efficient
- EV subsidies give unfair advantage to developed counties + info gaps mean that subsidy level = difficult to set
1.4.2b
Cause of Govt Failure - Unintended Consequences
- ⬆️direct tax e.g more income tax discourages ppl from working = welfare trap as they are better off on benefits form govt
- indirect tax redistributes income thus despite income everyone pays same e.g VAT+laffer curve +regressive as easier to live of benefits
1.4.2b
Cause of Govt Failure - Excessive Administrative costs
Admin costs > welfare benefit
1.4.2b
Cause of Govt Failure - Information Gaps
- Hayek’s argument on why govt should not intervene
- gathering all info = time consuming + expensive + opportunity cost
- govt might get its calculations wrong
