11- Gov intervention

Question 1

Ways government to intervene to internalise externalities

Answer 1

• Indirect tax
• Subsidy
• Regulation
• Price controls (min and max prices)
• Property rights
• State provision

Question 2

Indirect tax definition

Answer 2

A tax on consumption.

Question 3

Impact of an indirect tax

Answer 3

• Increases a firm’s costs of production

- BUT: can be transferred to consumers

Question 4

When is an indirect tax imposed?

Answer 4

When there is an overconsumption and overproduction.

Question 5

Positive of indirect tax

Answer 5

• Internalises externality
• Hypothecated tax- can be further used to solve market failure (revenue gained from gov can be used for info provision, to subsidies alternatives)

Question 6

Issues of indirect taxes

Answer 6

• If demand is inelastic- lack of responsiveness to tax
• Difficulty to set tax at right level- externality can’t be measured
• Gov failure (unintended consequences):
  Regressive taxes (hit the poor)
  Black market- poor quality
  If the tax is too high- firms may shut down

Question 7

Subsidy definition

Answer 7

Money grant given to producers by the government to lower costs of production and encourage an increase in output.

Question 8

When is a subsidy used?

Answer 8

When there is an underproduction or underconsumption.

Question 9

Positives of a subsidy

Answer 9

• Solves underproduction/consumption

- Allocative efficiency- welfare gain

Question 10

Issues with subsides

Answer 10

• Costly
• High opportunity costs (potential future tax rises or spending cuts)
• Difficult to set subsidy at the right level- externality is unknown- may lead to government failure
• Subsidy dependency
• Firms may not use subsidy effectively
• Demand has to be elastic- inelastic won’t solve market failure

Question 11

When are min prices used?

Answer 11

To discourage demerit goods (where there is a negative externality in consumption).

Question 12

Issues with min prices

Answer 12

• Price inelastic demand- min prices would be ineffective
• Regressive- will burden the poor
• Black markets (loss in gov tax revenue) or cheaper, worse quality goods
• Difficult to know the right level:
  Too high- firms will shut down
  Too low- won’t lead to right outcomes
  BUT: if demand is inelastic will lead to higher revenue for firms

Question 13

When are max prices used?

Answer 13

To encourage more consumption for necessity goods.

Question 14

Issues with max prices

Answer 14

• Shortage
• Black markets
• Lower quality
• Enforcement
• Difficult to set prices at the right level
• Potential cost- to overcome excess demand

Question 15

Regulation definition

Answer 15

A rule/law enacted by the government that must be followed by economic agents to encourage a change in behaviour.
It does not work through the market.
COMMAND AND CONTROL SYSTEM

Question 16

Command element of regulation

Answer 16

• Bans
• Limits- age limits on alcohol and smoking
• Caps- emission caps
• Compulsory- vaccinations
• Innovative regulations

Question 17

Control element of regulation

Answer 17

• NEEDED FOR COMMAND TO WORK
• Strong enforcement needed if not no incentive
• Punishment

Question 18

Positives of regulation

Answer 18

• Can force a change in behaviour to solve issues in the free market
• Leads to allocative efficiency and a welfare gain

Question 19

Issues of regulation

Answer 19

• If one command and control break- regulation may break down
• Regulation is costly (the administrative cost of control)
• Is command at right level?:
  Too high- may burden firm with higher costs who may offshore leading to unemployment.
  Too low- not sufficient enough to force behaviour change
• Unintended consequences (gov failure)
• Firms try to game the system
• Black market (if consumers can’t consume) (loss of tax revenue)
• Equity

Question 20

Property rights definition

Answer 20

The legal ownership of a resource

Question 21

Tragedy of the common definitions

Answer 21

A situation where there is overconsumption of a particular product/service because rational individual decisions lead to an outcome that is damaging to the overall social welfare.

Question 22

What do property rights help to solve?

Answer 22

Tragedy of the commons

Question 23

How property rights help solve tragedy of the commons

Answer 23

With property rights only the private producer will suffer from their exploitation and now they are incentivised to look after what they have.
If enforced, it will reduce quantity to the socially optimum level.

Question 24

Issues with property rights

Answer 24

• Can they be efficiently distributed- i.e. it is hard to divide seas
• Enforcement needed- COST
• Equity- who gets the rights?
  maybe a 3rd party like a gov agency should

Question 25

How tradeable pollution permits work

Answer 25

1) The gov sets a socially optimal quantity that it pollutes 2) Gov issues permits to firms to match the cap. Then a market for permits is created. 3) Firms then have a decision to make: - Invest in green tech (externality internalised) - Buy spare permits (Polluter pays in most efficient ways) 4) The system is then enforced 5) Pollution is reduced to the socially optimal level 6) There is now always an incentive to invest in green technology for: i) Profit off selling permits ii) Firms won't be burdened when permit prices rise

Question 26

Advantages of pollution permits

Answer 26

- Since the government caps the number of permits, it is guaranteed that pollution will fall to the targets set by the government. This will maximise social welfare. ● The government can raise revenue by selling permits and by fining firms who exceed their pollution limit. ● This encourages companies to use and invest in green technology. ● Firms are able to make their own decisions about whether to cut pollution or buy more permits. This helps encourage efficiency, as seen by the numerical example (this is not necessary in an exam but helps to understand the concept).

Question 27

Issues with pollution permits

Answer 27

- Gov may be too generous - Hard to measure pollution and levels can be hid - Costly - Rich can buy permits from the poor - Inelastic demand