Theme 1 Topic 4 Flashcards
Govern,ents intervene to reduce market failure to : (5)
- Eliminate negative externalities
- Maximise positive externalities
- Increase supply of merit goods
- Reduce supply of demerit goods
- Supply public goods that would be under supplied by the market
Reduce inequalities in the distribution of income and wealth : (3)
- Unequal distribution can lead to poverty
- Tensions in society can be created
- A breakdown in society causes further market failure
Governments intervene to support UK industry :
Full employment is a government target.
Certain industries are more important than others as they employ large amounts of labour.
Infrastructure is essential if businesses are to provide quality services.
6 ways in which a government can intervene to correct market failure :
- Indirect tax
- Subsidies
- Maximum and minimum prices
- Trade pollution permits
- State provision of public goods
- Regulation
Taxation ?
Medium through which governments finance their spending and control the economy.
Indirect tax?
Tax on a good or service.
Direct tax ?
levied directly on an individual or an organisation’s income/profits and is paid directly to the government by the taxpayer.
Incidence/burden tax ?
The amount that the consumer (or producer) will pay for the tax.
Specific tax ?
Set amount per unit.
Parallel shift upwards in the supply curve.
Ad valorem tax ?
% of the price of the good/service.
The more expensive tje product, the greater the tax on it.
Shifts supply curve upwards yet also tilts.
As prices increase, so do taxes.
Indirect tax graph :
It increases the cost of supply for a firm, leading to a shift in supply to the left and upwards.
Quantity supplied falls. Prices increase (P-P1)l
Increase im tax causes price to rise by the vertical distance between the supply curve.
The incidence of the tax paid for by the producer is from P to P0.
The incidence of tax paid for by the consumer is from P1 to P.
2 Advantages of indirect taxes :
- It internalises the externality - the market produces at the social equilibrium position and social welfare is maximised.
- It raises government revenue. This could be used to solve the externality in other ways (e.g. education). This may help goods become more elastic in the long run. The effect depends on what the government does with the revenue they raise.
3 disadvantages of indirect taxes :
- Difficult to know the size of the externality and so it’s difficult to target the tax. The effect depends on where the tax is set. The government suffers from imperfect information when setting the tax.
- If demand for the good is inelastic, then the tax will be ineffective at reducing output.
- Taxes are regressive - people with a lower income spend a larger % or their income on indirect taxes than those with a higher income.
Examples of indirect taxes for externalities :
Fuel duties, landfill taxes, sugar taxes.
examples of subsidies :
biofuels, solar panels.
subsidies graph :
cause a decrease in costs of supply for a firm.
causes a shift in the supply curve down and to the right.
quantity supplied will increase by Q to Q1.
prices will fall from P to P1.
it causes supply to fall by a vertical distance between the supply curves.
it is shared between consumer and producer.
upper area : gain to consumers
lower area : gain to producers
both areas : government expenditure on subsidy
vertical line : incidence of subsidy in government
2 advantages of subsidies :
- society reaches the social optimum output and welfare is maximised.
- they can have other positive impacts (e.g. encouraging exports)
3 disadvantages of subsidies :
- high opportunity cost for the government as they spend lots of money.
- difficult to target since the exact size of the externality is unknown
- once introduced, they are difficult to remove.
price control ?
when the government sets max or min prices for a good/service
advantage of max + min prices :
max price ensures all goods are affordable yet minimum prices ensure producers get a fair price.
these can reduce poverty and increase equality
disadvantage of max + min prices :
hard for the government to know where to set prices.
hard to know the size of the externalities.
has implications on the size of excess supply/demand.
maximum price graph :
- A maximum price at P1 causes excess demand (Q1Q2) because consumers want more at the lower price.
- The government may set a maximum price to protect consumers from being exploited.
minimum price graph :
- A minimum price at P1 causes excess supply (Q1Q2) because firms want to supply more at the higher price.
- The National Minimum Wage (NMW), introduced in 1999, aimed to redistribute income to low-paid workers.
- Some argued that it could lead to lower demand for workers, causing excess supply of labor (unemployment).
what is a minimum price ?
- A minimum price is the lowest price suppliers can legally charge for a good.
- It’s used for goods with negative externalities to increase price and reduce consumption.
- For it to be effective, the minimum price must be set above the current equilibrium price.
what is a maximum price ?
- A maximum price is the highest price suppliers can legally charge for a good.
- It’s used for goods with positive externalities and to prevent monopolies from exploiting consumers.
- For it to be effective, the maximum price must be set below the current equilibrium price.
what is a buffer stock scheme ?
both max and min prices are implemented at the same time.
the government buys up excess supply when the equilibrium price is below the minimum price and sells their stock to meet excess demand when price exceeds the maximum price.
prevents price fluctuation and provides stability.
causes increased government costs.
What is a subsidy ?
Money grant given to firms by the government to reduce costs of production and encourage an incessant in output.
