Year 1 micro - Market failure Flashcards
why are indirect taxes used
- a form of govt intervention used to raise government revenue (like VAT)and to solve market failure( reduce consumption of demerit goods)
what are indirect tax
- a tax on expenditure that increases cost of production for firms but can be transferred to consumers via higher prices
what are direct taxes
taxes on income that can’t be transferred, eg National insurance, income tax, corporation tax
what are specific indirect taxes
taxes per unit , eg wine duty having a tax of £2.23 per bottle, these shift the supply curve parallel to the left
what is an ad valorem tax
a tax as a percentage of the price being charged, eg VAT at 20%, the supply curve will shift pivoted
impacts of indirect taxes on the market
- supply curve shifts left/upward (increased cop) to s1 plus tax
- price increases and quantity decreases
impact of indirect taxes on the economic agents
Revenue Generation for Government
- Indirect taxes generate significant revenue that can fund public goods and services.
Impact: This provides resources for healthcare, education, and infrastructure without directly taxing incomes.
Encourages Behavioral Change
- Taxes on demerit goods (e.g., tobacco, alcohol) discourage consumption by increasing prices.
- Helps to address negative externalities and improve societal health outcomes.
Flexibility in Implementation
- Indirect taxes can be targeted at specific goods, allowing governments to address market failures efficiently.
- Helps in regulating markets without overburdening taxpayers universally.
Incentivizes Efficiency
- Firms may innovate to reduce tax liabilities, such as by lowering pollution or improving production methods.
- Leads to greener and more efficient processes in some industries
what are subsidies
a money grant given to firms by the government to reduce costs of production and encourage an increase in output
what are subsidies used for
- to solve market failure by increasing consumption and production
- increase affordability
describe the impact of a subsidy on a graph
- supply curve shifts right , S1 to S1 + sub
- ## price decreases, quantity increases
impact of subsidies on stakeholders
consumers - lower prices is good, but how will the subsidies be funded, tax increase
producers / workers - increase in producer revenue and surplus. since labour is a derived demand , higher demand for workers, higher employment
govt - will benefit from subsidies if two main aims are achieved, but subsidies may be expensive, opportunity cost may occur. also, are producers taking advantage of these subsidies, they could be using the extra revenue to pay off debt/pay shareholders
what is a minimum price
a fixed price set by the government above the equilibrium market price
why is minimum price used
- to protect producers from price volatility (eg farmers)
- to solve market failure (reduces negative externalities)
impact of minimum price on economy
- prices increase from p1 to pmin
- there is contraction in demand, moves up the demand curve
- extension of supply - moves up
- excess supply is created
what is intervention buying
When the government buys excess supply
impact of minimum price on stakeholders
consumers - lower consumer surplus as they are paying higher prices, quantity and choice are lower, affordability is lower for low income households, IT IS REGRESSIVE. taxes may also be higher to fund intervention buying
producers - if there is intervention buying, producers revenue increases, increased producer surplus. if not, cop increases, output decreases, firms may leave the market
government - good if they reach their objectives
- however effects on consumers such as the regressive nature, also unintended consequences like black markets forming
- concern abt intervention buying cost, oppurtunity cost?? also what r they gonna do after they buy the excess supply
Meaning of regressive
when the price of somethingg takes a larger proportion of lower households income
what is maximum price
a fixed price made by the government below the equilibrium market price
what does a max price aim to do
increase affordability of necessity goods/services
impact of max price
- price decreases, demand extends, supply contracts
- excess demand/shortage
- means that people may still not be able to access goods because there is not enough of it
advantages of maximum price on economic agents
Consumers
- Increased Affordability: Ensures essential goods and services (e.g., housing or food) remain affordable, benefiting low-income households.
eg, Rent controls in urban areas help tenants access housing that might otherwise be unaffordable.
- Prevents exploitation in times of shortages, such as during natural disasters, where prices for essentials like water could otherwise skyrocket.
Producers
- Encourages Efficiency: Forces producers to cut unnecessary costs and innovate to maintain profitability under price constraints.
Example: Limiting energy prices might push companies toward cost-saving technologies.
Government
- Social Equity: Enhances the government’s ability to address income inequalities and protect vulnerable groups.
Example: Setting maximum drug prices ensures healthcare affordability and improves public welfare.
- Policies protecting consumers from high prices can improve public perception and political stability
what additional labels do we add to the supply curve
S = MPC = MSC
what additional labels do we add to the demand curve
D = MPB = MSB
Private costs are…
direct costs incurred by individuals or firms when producing or consuming a good or service
eg raw materials
what are social costs
private costs + any external costs
what are external costs
costs imposed on third parties who are not directly involved in the economic transaction
eg pollution
what are private benefits
individual consumer benefit upon consumption
what are social benefits
private benefits + external benefits
what happens at allocative efficiency
- there is maximisation of society surplus: the sum of producer and consumer surplus, that occurs at equilibrium
- maximisation of net social benefit, where MSB = MSC
- where resources perfectly follows consumer demand, no excess
assumptions for microeconomic equilibrium
- there are many buyers and sellers in the market
- both buyers and sellers have perfect information
- there are no barriers to entry
- firms are profit maximisers and consumers are utility maximisers
what is the private optimum
MPC = MPB
what is social optimum
MSC = MSB
what is market failure
when there is a misallocation of scarce resources at the socially optimum level of output
causes of market failure
negative and positive externalities, but these are ignored by firms and consumers
demerit and merit goods - there is not enough information about how good/bad these things are for us
- public goods - free rider problem / they are under provided by the free market
- common access resources (tragedy of the commons) - things that are over consumed and produced
- income inequality
- monopoly power - one dominant selling and high barriers to entry
- factor immobility
what are negative externalities(NE)
costs on third parties because of the actions of a separate agent
NE in production examples
- costs to 3rd parties as a result of the actions of producers
- air pollution (general public)
- resource depletion (future gen)
- resource degradation (residents affected by waste
- deforestation
negative production externality graph
- MSC > MPC
- welfare loss triangle points towards the social optimum
- Firms are ignoring social costs because of self interest, leading to over production
- prices are too low at p1, p1 only accounts for private costs, not external/social costs
- These result in a misallocation of resources
What are negative externalities in consumption
Costs to 3rd parties as a result of the actions of consumers
- For example, smoking, alcohol, sugary drinks, and fast food
NE in consumption on a graph
- MSB < MPB
- welfare loss points to the social optimum
- Consumers prioritise their own private benefits over social benefits due to self interest
or
what are positive externalities
benefits to third parties as a result of the actions of consumers/producers
- eg healthcare
- excercise
- healthy eating
- in work training
- research and development
positive externality impact
- in consumption - MSB > MPB
- in production, MSC < MPC
why is there a welfare loss with positive externalities
social benefits are greater than social costs, by not producing extra units of quantity demanded, we lose out on potential extra social benefit
- underconsumption and underproduction
evaluation points for maximum price
Short-Term Relief vs. Long-Term Impact
- While maximum prices provide immediate affordability for consumers, they may disincentivize producers in the long run.
- Asymmetric info - govt may set the cap too high or too low
- Maximum prices are more effective in markets with relatively elastic supply, where producers can adjust to meet demand.
Evaluation: In markets with inelastic supply (e.g., housing), shortages are more likely, reducing the policy’s effectiveness.
Targeting Essential Goods
- Maximum prices are most beneficial for essential goods and services, ensuring affordability for low-income households.
- If applied to non-essential goods, the policy may have minimal social benefit while still creating distortions in the market.
Maximum prices benefit those who can access the good at the capped price. However, shortages may exclude some consumers altogether.
.
Risk of Shortages
- Maximum prices below the market equilibrium may lead to excess demand and insufficient supply..
Black Markets
- Artificially low prices can incentivize illegal markets, where goods are sold at higher prices. in the case of excess demand
- The scale of black markets depends on enforcement strength.
Quality Decline
- Producers might cut corners to maintain profitability under capped prices, resulting in lower-quality goods and services.
Impact on Supply
- Reduced profitability may disincentivize production, particularly for small-scale or marginal producers.w
disadvantages of indirect taxes
Regressive Nature
- Indirect taxes disproportionately affect low-income households, as they spend a larger share of their income on taxed goods.
-May increase inequality unless mitigated through targeted subsidies or exemptions.
Administrative and Compliance Costs
- Businesses bear the cost of implementing, reporting, and remitting taxes to the government.
- Can reduce profitability, especially for small enterprises.
Black Market Risks
- High taxes on certain goods (e.g., alcohol or fuel) can encourage smuggling or illegal trade.
- Reduces government revenue and undermines legitimate businesses.
Elasticity Dependency
- Effectiveness in changing behavior depends on the price elasticity of demand. For inelastic goods (e.g., fuel), consumption may not decrease significantly.
- Limits the tax’s effectiveness in achieving social objectives.
evaluation points for indirect taxes
- The success of indirect taxes often depends on being paired with other policies, such as subsidies for healthier alternatives or investments in green technology.
- Indirect taxes may inadvertently encourage undesirable outcomes, such as black markets or tax evasion
- The success of an indirect tax in reducing harmful consumption depends on the good’s price elasticity.
Evaluation: For inelastic goods, complementary policies like public education or subsidies for alternatives may be necessary.
advantages of minimum price
Producers
Higher and Stable Incomes: Producers benefit from a guaranteed minimum price, ensuring a stable income, particularly in volatile markets like agriculture,where prices can fluctuate significantly due to factors like weather conditions and global supply changes
Encourages Investment: Predictable earnings encourage long-term investment in quality and efficiency.
Consumers
- Reduced Overconsumption: Higher prices on demerit goods (e.g., alcohol) can discourage excessive consumption, leading to societal benefits.
Government
- Reduction in Negative Externalities: For harmful goods, a minimum price can help reduce associated societal costs (e.g., healthcare for alcohol-related illnesses).
- Market Stabilization: Minimum prices can stabilize markets during periods of low demand or oversupply
disadvantages of minimum price
Guaranteed higher prices may lead to surplus production, particularly in agricultural markets.
, may cause firms to not earn enough profit and eventually leave the market
- Some industries may become reliant on minimum price schemes for survival.
- Excess Supply and Government Surpluses
A minimum price set above the equilibrium price leads to excess supply, as producers are willing to supply more than consumers demand. This surplus can be costly for governments, as they may need to buy and store excess goods (e.g., in agricultural markets) or risk wastage. - Higher Prices for Consumers
Since the minimum price prevents goods from being sold below a certain level, consumers face higher costs. This can reduce affordability, particularly for essential goods such as food and housing, disproportionately affecting low-income households and leading to lower overall consumer welfare. - Risk of Black Markets and Illegal Sales
When official prices are kept artificially high, some buyers may seek cheaper alternatives through informal or illegal markets. This undermines the policy’s effectiveness, leading to enforcement costs and potential losses for legitimate businesses. - Inefficiency and Resource Misallocation
By artificially inflating prices, inefficient producers who would otherwise exit the market continue to operate. This distorts resource allocation, as firms have less incentive to innovate, cut costs, or improve productivity since they are guaranteed a higher price regardless of efficiency.
eval points for minimum price
Impact on Equity
- A minimum price may disproportionately affect low-income consumers, particularly if applied to essential goods. Mitigating measures like targeted subsidies or tax relief can address this.
Market Efficiency
- While a minimum price may stabilize producer incomes, it risks distorting market dynamics by encouraging overproduction or reducing consumer demand.
Elasticity of Demand
- The effectiveness of minimum pricing depends on the price elasticity of the good. For inelastic goods, consumers may continue to purchase despite higher prices, while for elastic goods, demand could fall significantly.
Targeted Application
- Minimum pricing works best when targeted at specific markets with clear externalities, such as alcohol or agriculture. Broad implementation may cause inefficiencies.
Complementary Policies
- Minimum pricing may need to be supported by other measures, such as investment in storage for surplus goods, subsidies for low-income households, or public awareness campaigns about harmful goods.
what is labour immobility
Labour immobility refers to the inability of workers to move between jobs due to barriers like a lack of skills (occupational immobility) or geographical constraints.
what are external benefits or costs
- benefits or costs outside the market transaction
- social - private benefits or costs
what is welfare loss
the excess social cost over social benefit for a given output
