Y12 Booklet 3: Government Intervention

Question 1

How can a government intervene to fix market failure? (8x)

Answer 1

Price-focussed:
- indirect tax - production subsidy
- price controls

Legal-focussed:
- regulation - property rights
- tradable permits

Provisions:
- info provision - state provision

Question 2

Indirect Tax

Answer 2

a tax levied on producers
affects supply

for negative externalities/demerit goods:
1) increases cost of production, less profit
2) less incentive to supply, S shifts left S1->S2
3) excess demand, price increases P1->P2
4) contraction of demand Q1->Q2, overconsumption/production corrected

Question 3

Graph for Indirect Tax

Answer 3

S shifts left

Question 4

(Production) Subsidy

Answer 4

extra money for producers
affects supply

for positive externalities/merit goods:
1) decreases cost of production, more profit
2) more incentive to supply, S shifts right S1->S2
3) excess supply, equilibrium price decreases P1->P2
4) extension of demand Q1->Q2, underconsumption/production corrected

Question 5

Graph for Production Subsidy

Answer 5

S shifts right

Question 6

Price Controls

Answer 6

setting a min. (floor) or max. (ceiling) price

for minimum price:
1) min. price must be above equilibrium price
2) contraction of D QE->QD, extension of S QE->QS
3) causes excess supply

for maximum price:
1) max. price must be below equilibrium price
2) extension of D QE->QD, contraction of S QE->QS
3) causes excess demand

Question 7

Graphs for Price Controls

Answer 7

Min. - D contracts, S extends
Max. - D extends, S contracts

Question 8

Regulation

Answer 8

laws passed and enforced by the government
can affect supply or demand

for supply:
1) increases cost of production, less profit incentive
2) S shifts left S1->S2, excess demand, equilibrium price increases P1->P2
3) contraction of demand Q1->Q2, overconsumption/production corrected

for demand:
1) changes tastes and preferences (e.g. by banning for u18s)
2) D shifts left D1->D2, excess supply, equilibrium price decreases P1->P2
3) contraction of supply Q1->Q2, overconsumption/production corrected

Question 9

Graphs for Regulation

Answer 9

S shifts left (regulation on production)
D shifts left (regulation on consumption)

Question 10

Information Provision

Answer 10

educates or advertises positives/negatives of a good
affects demand

for merit goods:
1) spread info so people understand benefit of good
2) changes tastes and preferences, demand shifts right D1->D2
3) excess demand, increases equilibrium price P1->P2, more profit incentive
4) supply extends Q1->Q2 , reaches SO, correcting underconsumption

for demerit goods:
1) spread info so people understand harm of good
2) changes tastes and preferences, demand shifts left D1->D2
3) excess supply, decreases equilibrium price P1->P2, less profit incentive
4) supply contracts Q1->Q2, reaches SO, correcting overconsumption

Question 11

Graphs for Information Provision

Answer 11

D shifts right (merit)
D shifts left (demerit)

Question 12

State Provision

Answer 12

the government allocates resources, often for no consumer cost
AVOID IN EXAMS, DIFFICULT TO ANALYSE

for missing markets/public goods:
1) government provides ‘free’ service/good
2) not literally free, uses tax money

Question 13

Graph for State Provision

Answer 13

Govt isn’t profit motivated, so PES = 0

Question 14

Property Rights

Answer 14

assign all property to a person/firm

for negative externalities:
1) a third party is given property rights, so interested/responsible
2) damage is caused by negative externalities
3) property owner can receive compensation
4) externalities are internalised and MPC=MSC

Question 15

Tradable Permits

Answer 15

allocate permits that limit negative externality (e.g. pollution)

1) government imposes limit on output and produces equal no. permits
2) allocates permits through grandfathering or auction
3) government reduces supply of permits so S shifts left S1->S2
4) excess demand for permits, equilibrium price increases P1->P2
5) firms only buy permit if “cost of permit” < MAC, so demand contracts Q1->Q2
6) reduces quantity of negative externality to SO, corrects market failure

Question 16

Graph for Tradable Permits

Answer 16

S1 = original number of permits created
S2 = reduced number of permits (by govt)

Question 17

What is it called when revenue is cornered off to further correct failure in a specific market?

Answer 17

Hypothecated
(Ring-fenced)

Question 18

What is an ad valorem tax?

Answer 18

A tax which is a % of price

Question 19

What is a unit tax?

Answer 19

A tax which is a set £/unit, regardless of price of the good

Question 20

What is MAC?
How does it affect a firm’s decision-making when referring to permits for pollution?

Answer 20

Marginal Abatement Cost
cost of reducing pollution per unit

if cost of permit < MAC:
firms will buy a permit, since it’s cheaper
if cost of permit > MAC:
firms will reduce pollution by a unit, since it’s cheaper

Question 21

What are the best evaluations like?

Answer 21

• SPECIFIC to the question, not generic points
• offer extra info and DETAIL from case study
• must be RELEVANT and CONTEXTUALISED
• offer PROS and CONS

Question 22

What are some generic evaluative points for government intervention?
(Only use in exam when made specific and contextualised)

Answer 22

1) opportunity cost - could resources be better used elsewhere?
2) information gaps - risk of inaccurate or not full information, could cause government failure
3) depends - does its effectiveness depend on a factor such as PED? could it be ignored completely?
4) unintended consequences - risk of black market? inflationary?
5) jurisdiction issues - difficult to impose laws across borders
6) does it target certain people? is this negative?