Unit 2B: Should governments intervene in markets? (microeconomics)

Question 1

Define underallocation

Answer 1

When too few resources are allocated to the production of a good relative to what is socially most desirable.

Question 2

Define negative externalities of consumption

Answer 2

The negative affects suffered by a 3rd party when a good or service is consumed

Question 3

Define social costs

Answer 3

These are the true (or full) costs born by society as a result of the economic actions of producers and consumers i.e. the sum of private costs and external costs.
The equation for social costs:
External costs + Private costs

Question 4

Define private costs

Answer 4

These are the costs borne by the individual economic units (individuals, firms, government). And example of a private cost is wage costs.

Question 5

Define social benefits

Answer 5

These are the full benefits enjoyed by society/the community as a result of the actions of consumers and producers.

Equation:

Social benefits = Private benefits + External benefits

Question 6

Define rivalrous

Answer 6

Goods and services are referred to as this when the consumption by one person or a group of people prevents others from consuming the same good.

Question 7

Define imperfect information

Answer 7

This exists when some stakeholders in an economic transaction have greater access to knowledge than others

Question 8

Define negative externalities of production

Answer 8

These are the negative affects suffered by a 3rd party when a good or service is produced

Question 9

Define equilibrium/market clearing

Answer 9

It is when demand equals supply. It is a state of balance with no tendency to change.

Question 10

Define government regulations

Answer 10

A type of government policy where governments enact regulations in the publics interest

Question 11

Define external costs

Answer 11

Any costs above and beyond private costs. negative affects suffered by 3rd parties as the result of consumption or production of a good/service for which no compensation is paid.

Question 12

Define the term ‘excludable’

Answer 12

Goods and services are referred to as this when it producers prevent a person or persons from consuming that good or service based on their willingness to pay/other factors

Question 13

Define disequilibrium

Answer 13

A state of imbalance where this is either excess demand (shortage) or excess supply (surplus). The forces of demand and supply will cause the price to change until an equilibrium is reached.

Question 14

Define the term ‘allocative inefeciency’

Answer 14

A loss of economic efficiency that can occur when the equilibrium for a good or service is not allocatively efficient.

Question 15

Define positive externalities of consumption

Answer 15

These are the benefits enjoyed by a 3rd party as a result of the consumption of a good/service

Question 16

Define the term ‘external benefits’

Answer 16

The advantages enjoyed above and beyond private benefits. These are the benefits enjoyed by a 3rd party as a result of the production/consumption of a good/service.

Question 17

Define government provision

Answer 17

The involvement of the government in the direct provision of goods/services with positive consumption externalities (e.g. providing healthcare or education)

Question 18

Define private benefits

Answer 18

These are the advantages enjoyed by individual economic units (firms, individuals, governments). An example of a private benefit is sales revenue.

Question 19

Define legislation

Answer 19

A type of government policy where the government uses its authority to enact laws in the publics interest

Question 20

Define the free rider problem

Answer 20

This occurs when people who benefit from the consumption of goods and services do not have to pay for them, thus there is overconsumption. This happens when consumers try to ‘ride on the backs’ of other consumers to maximise utility. It happens because of the non-excludable nature of public goods. As others cannot be prevented from enjoying the benefits of them there is no incentive to pay for them. This is why pure public goods are not provided in a free market, and the government thus has to step in and provide them.

Question 21

Define positive externalities of production

Answer 21

The beneficial affects enjoyed by a 3rd party when a good or service is produced

Question 22

Define overallocation

Answer 22

Occurs when too much of a resource is allocated to the production of a good relative to what is socially most desirable, leading to overproduction

Question 23

What are the advantages and disadvantages of a market system?

Answer 23

Question 24

Define a market failure

Answer 24

Market failure occurs due to inefficiency in the allocation of resources, and, therefore, in the production of goods and services. A price mechanism fails to account for all of the costs and benefits involved when providing or consuming a specific good, leading to overproduction of some goods and under-production of others.

Question 25

What are the 6 types of market failure?

Answer 25

1. Externalities
2. the lack of provision of public goods by private firms (so the government has to step in and provide them)
3. The underprovision and underconsumption of merit goods (the government has to step in and ‘top up’ the merit goods provided by private firms at subsidised rates or free of charge
4. The overprovision and overconsumption of demerit goods (government has to step in and prevent or regulate or tax their production and consumption)
5. The abuse of monopoly power
6. Factor immobility

Question 26

Explain what externalities (in general) are and why they are bad

Answer 26

Externalities are when the actions of consumers or producers affect 3rd parties.

If externalities exist then profits and prices do not represent the true costs and benefits to society of economic activity. This leads to a misallocation of resources, too much or too little of a good is produced.

Question 27

Explain how negative externalities occur

Answer 27

Negative externalities occur either when external costs are greater than private costs and there is overproduction, or when private benefits are greater than external benefits and there is thus overconsumption.

An example is the second hand smoker who inhales the smoke of someone else’s cigarette.

Question 28

Explain how positive externalities occur

Answer 28

These occur either when social benefits are greater than private benefits and there is underconsumption, or when private costs are greater than social costs and there is underproduction.

e.g. the full benefits of vaccines is underestimated by consumers thus they demand consume less of them then is optimal to society.

Question 29

Define public goods

Explain why they are examples of market failures

Answer 29

Goods and services which would not be at all provided by the market. They have the characteristics of non-rivalry and non-excludability. For example, flood barriers.

They are examples of market failures because in a market system they are not provided at the socially optimal rate.

Question 30

What are a few examples of public goods?

Answer 30

• Defence
• Criminal justice system (police & prison)
• Street lighting
• Flood barriers

Question 31

Define private goods

Answer 31

Goods provided by firms in the private sector, with the aim of selling them and acquiring profit. They have the characteristics of being rivalrous and excludable. Goods are typically made excludable by charging a price for them.

Question 32

What is a problem associated with public goods?

Answer 32

The free rider problem

Question 33

Define merit goods

Answer 33

Goods and services considered to be beneficial to people. These goods are underprovided and so underconsumed by the market. They are g/s that should be provided in greater quantities to be socially optimal. (e.g. healthcare, education)

Question 34

Explain why merit goods are examples of market failures

Answer 34

1. Imperfect information: Consumers and producers lack perfect information about the FULL benefits of consuming and producing merit goods for themselves and others.
2. Positive externalities

Question 35

Define demerit goods

Answer 35

Goods and services which are considered to be harmful for people and which are overproduced by the market and thus overconsumed.

Question 36

Explain why demerit goods are examples of market failures

Answer 36

1. Imperfect information: Consumers are not as aware of the FULL costs and harmful impacts of using these
2. Negative externalities: It is assumed that producers and consumers only take into consideration private costs, but that is not the case for these.

Question 37

Define a monopoly

Answer 37

A market structure where there is only a single supplier of a g/a. The firm IS the industry.

Question 38

Why do monopolies cause market failures?

Answer 38

When monopolies abuse their power, they can restrict the supply of a g/s in order to raise its price beyond that which is socially optimal. Such behaviour is therefore an example of a market failure as resources are misallocated. A government may intervene by breaking the monopoly up, preventing mergers from taking place that would create a monopoly, fining the monopoly, regulating monopolies, or subsidising/assist smaller firms and in doing so make it cheaper for them to enter and make the industry more competitive.

Question 39

Define factor immobility

Answer 39

This is where resources cannot easily or quickly be relocated to their next best use

Question 40

What are the 2 types of factor immobility? Define both

Answer 40

Geographic: Where it is challenging to move FOP from one region to another (e.g. workers)

Occupational: Where it is challenging to move FOP from one type of work/job role to another (this causes structural unemployment)

Question 41

Define subsidies

Answer 41

These are financial support paid by the government to firms

Question 42

Define indirect taxes

Answer 42

These are taxes placed on expenditure. They are added to the selling price of a good/service.

Question 43

Define carbon taxes

Answer 43

A tax per unit of carbon emissions of fossil fuels, considered by many countries to be a policy which deals with the threat of climate change.

Question 44

Define direct taxes

Answer 44

Taxes paid directly to the government tax authorities by the taxpayer, including personal income taxes, corporate income taxes, and wealth taxes.

Question 45

Define a black market

Answer 45

It can also be called a ‘parallel market’. It refers to a market where a buying/selling transaction is unrecorded. It may involve legal goods/services (e.g. a plumber fixing the plumbing without reporting the income) or for illegal goods/services (e.g. drugs). It may occur due to price ceilings leading to shortages.

Question 46

Define the burden/incidence of a tax

Answer 46

The ultimate payers of the tax

Question 47

What are the 5 ways in which a government may intervene in a market?

Answer 47

1. Subsidies
2. Indirect taxes
3. Maximum prices
4. Minimum prices
5. Changing/introducing Rules and regulations, Imposing Fines, Nationalising privately run organisations

Question 48

Examples of indirect tax:

These will affect _____ on the first instance

Answer 48

e.g. VAT/GST (Value added tax, goods and service tax)

Producers

Question 49

Direct taxes will affect _____ and _____ on the first instance

Answer 49

Individuals, households

Question 50

Define tax revenue

Answer 50

This is the income received by the government as a result of taxing goods/services or incomes.

Question 51

You should know how to do the indirect taxes diagram for an inelastic product and an elastic product

Answer 51

Question 52

What are the advantages of indirect taxes?

Answer 52

• Since it increases the price it reduces quantity demanded for goods/services with negative externalities
• It generates tax revenue for the government which they can use to fund important goods and services

Question 53

What are the disadvantages of setting indirect taxes

Answer 53

• The indirect tax will be regressive so it will affect the poorer classes.
• Demand for these kinds of goods usually is inelastic - so consumers won’t mind as much if the tax burden is passed onto them.

Question 54

What are all the justifications for subsidies?

Answer 54

• Helping poorer families e.g. food and childcare costs
• Protect jobs in loss making industries
• Making some healthcare treatments affordable
• Reduce the cost of training and employing workers

Question 55

Define a maximum price control

Answer 55

These are often imposed on necessities so that they can be accessed by everyone. They are placed below the market equilibrium price - leading to a shortage so g/s have to allocated by queuing/waiting lists or by the use of ballots. Black markets often arise.

Question 56

What are the advantages of a maximum price control?

Answer 56

• The poor can now afford the (merit) goods
• Government popularity may increase

Question 57

What are the disadvantages of a maximum price control?

Answer 57

Excess demand = leads to shortages = leads to blackmarkets = price will be above maximum price control = rationing may have to start happening = question of who gets what aries

Producers profits may fall = lower standards of living = firms may shut down = lots of job losess

Question 58

Define a minimum price control

Answer 58

These will be set by the government when it believes there is abuse of market power or that prices are unfair/too low. The government sets a floor beneath which goods and services cannot be sold for lower prices. The minimum price is above the market equilibrium If they were placed below they would make no impact.

Question 59

What are the advantages of a minimum price control?

Answer 59

• Producers gain as there may be more profit
• Producers are protected against low cost competition
• Employees gains as there is increase employment as output increases.

Question 60

What are the disadvantages of a minimum price control?

Answer 60

• Creates a surplus of goods in the market = the government then has to decide how to deal with this = opportunity cost
• Firms may become less efficient as they earn higher prices for their products.
• Consumers are worse off as they have to pay higher prices
• Foreign producers are negatively impacted if the surplus is exported

Question 61

Define privatisation

Answer 61

Transfer of the ownership of asses from the public sector to the private sector

Question 62

Define nationalisation

Answer 62

Purchase of private sector assets by the government

Question 63

Advantages of privatisation:

Answer 63

• The ability to earn one-off privatisation proceeds from the sale of state owned assets
• Privatisation helps to reduce government debt in 3 ways: Govt no longer has to maintain the operation of state owned enterprises, It earns revenue from the sale of a privatised business, and the private sector firm pays corporate taxes.
• Reduces cost to taxpayers since they no longer have to pay to finance the operations of the enterprise
• Private sector business have the incentive and competition to make the enterprise more efficient and innovative

Question 64

What are the disadvantages of privatisation?

Answer 64

• Could create a private sector monopolist, consumers may face higher prices
• To protect public interest, privatisation may still require govt intervention and regulation
• Opportunity cost, state owned businesses could provide education instead for example

Question 65

What do monopolies do to consumers?

Answer 65

Rais price of g/s byeong the socially optimal rate

Question 66

What are the advantages of govt provision?

Answer 66

• More accessible even to people in lower classes
• g/s will have both private and external benefits

Question 67

What are the disadvantages of govt provision?

Answer 67

• Opportunity cost, they could have spent it on something else like education/healthcare or something
• G/s which are free of charge may be over consumed, so long queues arise
• Free rider problem

Question 68

Draw a graph for taxes, label the consumers burden, firms burden, tax income, and welfare loss

Answer 68

Question 69

Draw and label all parts of a subsidy graph

Answer 69

https://www.youtube.com/watch?v=aUAR9yOWNlo