Year 1 micro - Market failure

Question 1

why are indirect taxes used

Answer 1

• a form of govt intervention used to raise government revenue (like VAT)and to solve market failure( reduce consumption of demerit goods)

Question 2

what are indirect tax

Answer 2

• a tax on expenditure that increases cost of production for firms but can be transferred to consumers via higher prices

Question 3

what are direct taxes

Answer 3

taxes on income that can’t be transferred, eg National insurance, income tax, corporation tax

Question 4

what are specific indirect taxes

Answer 4

taxes per unit , eg wine duty having a tax of £2.23 per bottle, these shift the supply curve parallel to the left

Question 5

what is an ad valorem tax

Answer 5

a tax as a percentage of the price being charged, eg VAT at 20%, the supply curve will shift pivoted

Question 6

impacts of indirect taxes on the market

Answer 6

• supply curve shifts left/upward (increased cop) to s1 plus tax
• price increases and quantity decreases

Question 7

impact of indirect taxes on the economic agents

Answer 7

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

Question 8

what are subsidies

Answer 8

a money grant given to firms by the government to reduce costs of production and encourage an increase in output

Question 9

what are subsidies used for

Answer 9

• to solve market failure by increasing consumption and production
• increase affordability

Question 10

describe the impact of a subsidy on a graph

Answer 10

• supply curve shifts right , S1 to S1 + sub
• ## price decreases, quantity increases

Question 11

impact of subsidies on stakeholders

Answer 11

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

Question 12

what is a minimum price

Answer 12

a fixed price set by the government above the equilibrium market price

Question 13

why is minimum price used

Answer 13

• to protect producers from price volatility (eg farmers)
• to solve market failure (reduces negative externalities)

Question 14

impact of minimum price on economy

Answer 14

• 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

Question 15

what is intervention buying

Answer 15

When the government buys excess supply

Question 16

impact of minimum price on stakeholders

Answer 16

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

Question 17

Meaning of regressive

Answer 17

when the price of somethingg takes a larger proportion of lower households income

Question 18

what is maximum price

Answer 18

a fixed price made by the government below the equilibrium market price

Question 19

what does a max price aim to do

Answer 19

increase affordability of necessity goods/services

Question 20

impact of max price

Answer 20

• 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

Question 21

advantages of maximum price on economic agents

Answer 21

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

Question 22

what additional labels do we add to the supply curve

Answer 22

S = MPC = MSC

Question 23

what additional labels do we add to the demand curve

Answer 23

D = MPB = MSB

Question 24

Private costs are…

Answer 24

direct costs incurred by individuals or firms when producing or consuming a good or service
eg raw materials

Question 25

what are social costs

Answer 25

private costs + any external costs

Question 26

what are external costs

Answer 26

costs imposed on third parties who are not directly involved in the economic transaction
eg pollution

Question 27

what are private benefits

Answer 27

individual consumer benefit upon consumption

Question 28

what are social benefits

Answer 28

private benefits + external benefits

Question 29

what happens at allocative efficiency

Answer 29

• 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

Question 30

assumptions for microeconomic equilibrium

Answer 30

• 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

Question 31

what is the private optimum

Answer 31

MPC = MPB

Question 32

what is social optimum

Answer 32

MSC = MSB

Question 33

what is market failure

Answer 33

when there is a misallocation of scarce resources at the socially optimum level of output

Question 34

causes of market failure

Answer 34

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

Question 35

what are negative externalities(NE)

Answer 35

costs on third parties because of the actions of a separate agent

Question 36

NE in production examples

Answer 36

• 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

Question 37

negative production externality graph

Answer 37

• 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

Question 38

What are negative externalities in consumption

Answer 38

Costs to 3rd parties as a result of the actions of consumers
- For example, smoking, alcohol, sugary drinks, and fast food

Question 39

NE in consumption on a graph

Answer 39

• MSB < MPB
• welfare loss points to the social optimum
• Consumers prioritise their own private benefits over social benefits due to self interest
  or

Question 40

what are positive externalities

Answer 40

benefits to third parties as a result of the actions of consumers/producers
- eg healthcare
- excercise
- healthy eating
- in work training
- research and development

Question 41

positive externality impact

Answer 41

• in consumption - MSB > MPB
• in production, MSC < MPC

Question 42

why is there a welfare loss with positive externalities

Answer 42

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

Question 43

evaluation points for maximum price

Answer 43

Short-Term Relief vs. Long-Term Impact
- While maximum prices provide immediate affordability for consumers, they may disincentivize producers in the long run.

• 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.

Question 44

disadvantages of indirect taxes

Answer 44

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.

Question 45

evaluation points for indirect taxes

Answer 45

• 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.

Question 46

advantages of minimum price

Answer 46

Producers
Higher and Stable Incomes: Producers benefit from a guaranteed minimum price, ensuring a stable income, particularly in volatile markets like agriculture.
Encourages Investment: Predictable earnings encourage long-term investment in quality and efficiency.

Consumers
- Improved Quality: If higher prices incentivize producers to improve product quality, consumers may benefit indirectly.
- 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

Question 47

disadvantages of minimum price

Answer 47

Producers

• 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.

Consumers
- Consumers pay more, particularly for essential goods, reducing disposable income and potentially exacerbating inequality. Lower CS
- Higher prices can encourage black-market activity, undermining legitimate businesses and reducing regulatory effectiveness.

Government
- In cases of overproduction, the government may need to purchase and store excess goods, increasing fiscal burden.
- Ensuring compliance with minimum price laws can be costly and administratively complex.

Question 48

eval points for minimum price

Answer 48

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.

Question 49

what is labour immobility

Answer 49

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.

Question 50

what are external benefits or costs

Answer 50

• benefits or costs outside the market transaction
• social - private benefits or costs

Question 51

what is welfare loss

Answer 51

the excess social cost over social benefit for a given output