1.4 Government Intervention

Question 1

indirect taxation advantages

Answer 1

-It internalises the externality
- the market now produces at the social equilibrium position and social welfare is maximised.
-It raises government revenue, which could be used to solve the externality in other ways such as through education. This may help goods to become more elastic in the long run. The effect will depend on what the government does with the revenue they raise.

Question 2

indirect taxation disadvantages

Answer 2

• It is difficult to know the size of the externality and so it is difficult to target the tax; the effect depends on where the tax is set. The government suffers from imperfect information when setting the tax.
• There could be conflict between the government goal of raising revenue and solving the externality, which makes setting the tax difficult.
• It could lead to the creation of a black market
• If demand for the good is inelastic, then the tax will be ineffective at reducing output.
• Taxes are politically unpopular and so governments may be reluctant to introduce them.
• They are regressive, meaning they the poor spend a larger proportion of their income on indirect taxes than the rich do

Question 3

example of indirect tax

Answer 3

landfill taxes, fuel duties, alcohol duties, tobacco duties, air passenger duties and sugar taxes

Question 4

subsides advantages

Answer 4

-Society reaches the social optimum output and welfare is maximised.
-They can have other positive impacts, such as encouraging small businesses, bringing about equality and encouraging exports

Question 5

subsides disadvantages

Answer 5

• The government has to spend a large amount of money, which will have a high opportunity cost.
• As with taxes, they are difficult to target since the exact size of the externality is unknown.
• Subsidies can cause producers to become inefficient, especially if they are in place
  for a long time.
• Once introduced, subsidies are difficult to remove.

Question 6

subsidies examples

Answer 6

biofuels, solar panels, apprenticeship schemes,
wind farms and rail industries.

Question 7

what needs to happen for the maximum price to take effect

Answer 7

it needs be set below the current price equilibrium

Question 8

what needs to happen for the minimum price to take effect

Answer 8

it needs to be set above the current price equilibrium

Question 9

maximum pricing

Answer 9

a legally imposed price for a good that the suppliers cannot charge above. They are set on goods with positive externalities. For example, they are set on food as a lack of food will have a negative impact on the NHS. This approach has sometimes been applied to rents for accommodation when prices are too high.

Question 10

minimum pricing

Answer 10

a legally imposed price at which the price of the good cannot go below. They can be set on goods with negative externalities, so that the price is raised to the social
optimum point and consumption is discouraged. They also encourage producers to produce goods, so can be set on goods with social benefits that are underprovided by the market.

Question 11

advantages of MP

Answer 11

They can be set where MSB=MSC, so allow for some consideration of externalities, and so help to increase social welfare.
-A minimum price will ensure that goods are affordable, whilst a maximum price will ensure that producers get a fair price. Both of these are able to reduce poverty and
can increase equity/equality.

Question 12

disadvantages of MP

Answer 12

There is a distortion of price signals and this causes excess supply/demand. Excess demand will lead to questions about how to allocate goods and excess supply will lead to questions about what to do with the surplus goods.
-It is difficult for the government to know where to set the prices, because of the difficulty of knowing the size of externalities and because it will have implications on
the size of excess supply/demand.
-Both can lead to the creation of black markets. Maximum prices may also lead to illegal bribes or discriminatory policies in allocating goods.

Question 13

buffer stock scheme

Answer 13

where both maximum and minimum pricing are implemented at the same time. the goverment will buy excess supply when the equilibrium price and sell their stock to meet their excess demand when price exceeds the maximum price.

Question 14

pollution permit

Answer 14

allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits the maximum amount of pollution.
Companies have to buy permits in order to pollute so, in an attempt to cut costs and increase profits, companies may use greener technology. Unused permits can be sold

Question 15

pollution permits advantages

Answer 15

-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 16

pollution permits disadvantages

Answer 16

-This can be expensive to monitor and police, but it will only work if it is monitored well. The government needs to impose fines that are large enough to ensure firms follow the regulation.
-It will raise costs for businesses, and it is likely that these higher costs will be passed onto consumers
-It may be difficult to know how many permits the government should allow.

Question 17

state provision of public goods advantages

Answer 17

-This corrects market failure by providing important goods which would otherwise not be provided. It will lead to improved social welfare.
-It can help to bring about equality, by ensuring everyone has access to basic goods.
-There will be benefits of the goods themselves, for example by providing healthcare, the government ensures that the workforce is healthy and so this can improve economic growth.
-By using competitive tenders (looked at in Theme 3), the government can ensure efficiency.

Question 18

state provisions of public goods disadvantages

Answer 18

-This is expensive and represents a high opportunity cost for the government. Administration costs are a problem
-Since the market is not involved, the government may produce the wrong combination of goods as consumers can not indicate their preferences. For example, there may be too many soldiers and too few hospital beds: if they were provided by the market, price signals would lead to a shift in resources.
-Democracy aims to reduce this problem, since consumers can vote for political parties whose aims are similar to their own.
-The government may be inefficient at production since they have no incentive to cut costs.
-Government officials may suffer from corruption and conflicting objectives.

Question 19

provision of information advantages

Answer 19

-This helps consumers to act rationally, which allows the market to work properly.
-It is best if the government uses this alongside other policies. For example, it can make demand more elastic in the long run and so help indirect taxes to become more
effective at reducing output.

Question 20

provision of information disadvantages

Answer 20

-This can be expensive for the government to do, incurring an opportunity cost.
-The government themselves may not always have all the information, so it may be difficult to inform consumers.
-Consumers may not listen to the information provided due to irrational behaviour.

Question 21

regulation

Answer 21

overnments are able to impose laws and caps to ensure that levels are set where MSB=MSC or to ensure that companies provide full information on products.

Question 22

regualtion advantages

Answer 22

This can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed. This will help to overcome market failure and
maximise social welfare.

Question 23

regulation disadvantages

Answer 23

-Laws may be expensive for the government to monitor, incurring an opportunity cost.
-They don’t take into account the different costs of following the laws for different companies. Compared with tradable pollution permits, regulation is a less efficient method of reducing pollution.
-The government can suffer from regulatory capture (looked at in Theme 3).
-Firms may pass on costs to the consumer in the form of higher prices.
-Excessive regulation may reduce competition in a market and efficiency, by increasing bureaucracy and reducing innovation.

Question 24

government failure

Answer 24

when government intervention in the market leads to net welfare loss and a misallocation of resources.

Question 25

distortion of price signals

Answer 25

Some types of government intervention change price signals in the market and distort the free market mechanism. As a result, they keep some companies in business when they are inefficient so the resources should be switched to somewhere else (subsidies) or make consumers pay too much for a good (taxes). Maximum and minimum prices lead to excess demand/supply and make it difficult to allocate resources.

Question 26

unintended consequences

Answer 26

Some interventions cause effects which the government did not intend to happen. Consumers and producers may react to new policies in unexpected ways and so the
policy doesn’t have the effect it should.

Question 27

excessive administration cost

Answer 27

In many cases, a lot of money that is allocated by the government is actually used up on basic administration costs. The social costs may be higher than social benefits,
once administration costs are taken into account.

Question 28

information gaps

Answer 28

Any decisions that the government makes must be based on some data but the information they have is always going to be limited.Cost and benefit forecasts of investment are often wrong and so the government
invests in a system where the costs are higher than the benefits, so there is welfare loss.