1.4 Government intervention

Question 1

What is the primary reason for government intervention in markets?

Answer 1

To correct market failure.

Question 2

What are indirect taxes?

Answer 2

Taxes on expenditure

Question 3

How do indirect taxes affect market price and demand?

Answer 3

They increase market price and contract demand.

Question 4

Give an example of an indirect tax.

Answer 4

A £1 tax per packet of cigarettes.

Question 5

What are ad valorem taxes?

Answer 5

Taxes that are percentages of the unit price, such as VAT.

Question 6

What determines the incidence of the tax?

Answer 6

The price elasticity of demand of the good.

Question 7

What is the theoretical outcome of imposing a tax on a demerit good?

Answer 7

To discourage consumption and reduce negative externalities.

Question 8

What are specific taxes?

Answer 8

Set taxes per unit, such as the fuel duty on petrol.

Question 9

What is a subsidy?

Answer 9

A payment from the government to a producer to lower production costs.

Question 10

What is the purpose of subsidies?

Answer 10

To encourage the consumption of merit goods.

Question 11

How do subsidies affect market prices and production?

Answer 11

They shift the supply curve to the left, increasing production and lowering prices.

Question 12

What does the vertical distance between supply curves represent in the context of subsidies?

Answer 12

The value of the subsidy per unit.

Question 13

When do consumers gain more from a subsidy?

Answer 13

When demand is price inelastic.

Question 14

What are some disadvantages of subsidies?

Answer 14

Opportunity cost to the government Potential higher taxes
Risk of inefficiency in firms
Government failure

Question 15

Give an example of a subsidy that promotes positive externalities.

Answer 15

Government subsidizing recycling schemes.

Question 16

What is the purpose of setting a maximum price?

Answer 16

To encourage the consumption or production of a good and prevent it from becoming too expensive.

Question 17

How do maximum prices prevent monopolies?

Answer 17

By ensuring that prices remain affordable for consumers.

Question 18

What could be a consequence of misjudging the optimum market price when setting maximum prices?

Answer 18

Government failure.

Question 19

What are potential benefits of maximum prices for consumers?

Answer 19

• Welfare gains by keeping prices low
• Increased efficiency in firms

Question 20

What negative impact could maximum prices have on firms?

Answer 20

Reduced profits leading to less investment in the long run.

Question 21

What is the purpose of setting a minimum price?

Answer 21

To discourage the consumption or production of a good.

Question 22

Give an example of a minimum price set by the government.

Answer 22

The National Minimum Wage.

Question 23

How do minimum prices affect demerit goods like alcohol?

Answer 23

They reduce negative externalities from consumption.

Question 24

What is the effect of a minimum wage on employment rates?

Answer 24

It can lead to a fall in the employment rate.

Question 25

What does an inelastic labor demand imply for the minimum wage's effect on employment?

Answer 25

There is only a small contraction in demand for labor.

Question 26

What positive externalities can minimum prices yield?

Answer 26

A decent wage increasing the standard of living for the poorest.

Question 27

What are tradeable pollution permits designed to limit?

Answer 27

Negative externalities in the form of pollution.

Question 28

How can tradeable pollution permits benefit the environment?

Answer 28

By encouraging firms to use green production methods.

Question 29

What revenue opportunity do governments have with pollution permits?

Answer 29

They can sell permits to firms.

Question 30

What is a potential disadvantage of tradeable pollution permits?

Answer 30

Firms might relocate to avoid limits on pollution.

Question 31

How might firms respond to higher production costs from permits?

Answer 31

They might pass the higher costs onto consumers.

Question 32

What is a potential cost of government-provided education?

Answer 32

Opportunity cost of spending their revenue.

Question 33

What is the role of government in providing information to consumers?

Answer 33

To prevent information failure.

Question 34

What is one regulatory measure related to education?

Answer 34

Minimum school leaving age.

Question 35

What positive externality can arise from a higher skilled workforce due to regulation?

Answer 35

Improved economic productivity.

Question 36

What is a challenge of enforcing a compulsory recycling scheme?

Answer 36

High administrative costs and policing difficulties.

Question 37

What consequence do firms face for failing to follow regulations?

Answer 37

Heavy fines.

Question 38

What can happen when governments intervene in markets?

Answer 38

They can worsen existing market failures or create new ones, resulting in net welfare loss to society.

Question 39

What is a potential cause of government failure related to price signals?

Answer 39

Distortion of price signals due to government subsidies.

Question 40

How can government subsidies lead to an inefficient allocation of resources?

Answer 40

By distorting the free market mechanism, preventing the market from acting freely.

Question 41

Give an example of government intervention that could lead to government failure.

Answer 41

Subsidising an industry that is failing or has few prospects.

Question 42

What causes unintended consequences in the context of government policies?

Answer 42

Unexpected reactions from producers and consumers that undermine the effectiveness of the policy.