1.4 Government intervention

Question 1

Government interventions

Answer 1

• Indirect taxes
• Subsidies
• Maximum price
• Minimum price
• Tradable pollution permits
• State provision of public goods
• Provision of information
• Regulation

Question 2

Advantages of indirect tax

Answer 2

• It raises government revenue, which could be used to solve the externality in other ways such as through education. This may help goods become more elastic in the long run. The effect will depend on what the government does with the revenue they raise.
• Few administrative costs involved with this method.

Question 3

Disadvantages of indirect tax

Answer 3

• Ineffective in reducing pollution if demand is price inelastic
• It is difficult to know the size of 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.
• They are regressive, meaning the poor spend a larger proportion of their income on indirect taxes than the rich do.

Question 4

Advantages of Subsidies

Answer 4

• Reduction in cost of production enabling suppliers to reduce the price
• Incentive for people to increase consumption
• Might help to reduce inequality

Question 5

Disadvantages of subsidies

Answer 5

• ineffective in increasing consumption if demand is inelastic
• Difficult of setting an appropriate subsidy because of the problem of quantifying external benefit.
• Once introduced, subsidies are difficult to remove.

Question 6

Maximum prices

Answer 6

A legally imposed price ceiling by the government which prevent prices from rising.

Question 7

Maximum price advantages

Answer 7

• Enable consumers on low incomes to be able to buy a product.
• Gives consumers more disposable income, boosting the economy.
• Stops businesses from overcharging.
• Help prevent an increase in the country’s rate of inflation.

Question 8

Maximum price disadvantages

Answer 8

• Danger of shortages: consumers are unable to find suppliers of the product.
• Encourages black market where people sells goods illegally at higher prices.
• Could make businesses lose profit.

Question 9

Minimum price

Answer 9

A legally imposed price floor by the government at which the price of the good cannot go below.

Question 10

Advantages of minimum price

Answer 10

• Reduce poverty
• Protects producers from prices falling too low and making their business unprofitable.

Question 11

Disadvantages of minimum price

Answer 11

• Higher prices for consumers
  -Decreased international competitiveness
• If the minimum guaranteed price is set too high, there will be surpluses each year.

Question 12

Tradable pollution permits

Answer 12

Allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits maximum amount of pollution.

Question 13

Advantages of tradable pollution permits

Answer 13

• Incentive for firms to reduce pollution
• Encourages innovation: firms develop cleaner method to lower costs.
• Generates government revenue

Question 14

Disadvantages of tradable pollution permit

Answer 14

• Large, efficient firms might buy up the permits and continue to pollute.
• It will raise costs for businesses and it is likely that these higher costs will be passed on to consumers.
• Expensive to monitor: It will only work if it’s monitored well.

Question 15

State provision of public goods

Answer 15

The usual policy response to the lack of provision of public goods by the free market is for the government to provide them, financed through taxation.

Question 16

State provision of goods advantages

Answer 16

• Greater equality: Ensures that everyone has access to basic goods.
• Corrects market failure by providing important good which would otherwise not be provided.

Question 17

State provision of goods disadvantages

Answer 17

• Expensive and represents a high opportunity cost for the government.
• Since the market is not involved, the government may produce the wrong combination of goods as consumers can not indicate their preference.

Question 18

Provision of information

Answer 18

When there is asymmetric information, the government provides information to allow people to make informed decisions.

Question 19

Provision of information advantages

Answer 19

• This helps consumers to act rationally, which allows market to work properly.
• It is best if the government uses this alongside other policies.

Question 20

Provision of information disadvantages

Answer 20

• Can be expensive for the government.
• The government themselves may not always have all the information, so it may be difficult to inform consumer.
• Consumers may not listen to the information provided due to irrational behaviour.

Question 21

Regulation

Answer 21

Governments 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

Government failure

Answer 22

When government intervention results in a net welfare loss.

Question 23

Causes of Government failure

Answer 23

• Distortion of price signals
• Unintended consequences
• Excessive administrative costs
• Information gaps

Question 24

Cause of Government failure: Distortion of price signals

Answer 24

• Government intervention often involves manipulation of prices, for example by maximum or minimum price controls.
• However, such measuring would undermine the key functions of the price mechanism.
• This could result in resources not allocated efficiently.

Question 25

Cause of Government failure: Unintended consequences

Answer 25

Some types of government intervention may have an impact that policy makers did not predict.

Question 26

Causes of Government failure: Excessive administrative costs

Answer 26

Although government intervention might seem to be desirable, the costs may be considerable. For example, the cost of administrating means-tested benefits may be very large.

Question 27

Cause of Government failure: Information gaps

Answer 27

When a government intervenes in a market it is unlikely to have all information required. Consequently, the intervention could move output further away from the socially optimal level.