1.4 government intervention in markets

Question 1

what are some ways in which the governments attempt to correct market failures?

Answer 1

• indirect taxes
• subsidies
• max and min prices aka ‘price ceiling’
• state provision of public goods
• provision of information
• government regulation

Question 2

what is the purpose of indirect taxes?

Answer 2

• used by the government to correct market failure by reducing the supply and quantity demanded of a product that is being overproduced/consumed e.g. cigarettes are subject to ad valorem taxes to discourage smoking

Question 3

how would firms respond to indirect taxes?

Answer 3

• they would respond by producing less because their costs of production have now risen due to the tax

Question 4

what are the advantages of indirect taxes?

Answer 4

• revenue generated from taxes can be allocated to specific areas of spending / to negate the negative externalities
• it helps to internalize external costs
• the use of the price mechanism leaves it up to consumers and producers to decide how to adjust their behavior

Question 5

what are the disadvantages of indirect taxes?

Answer 5

• they are difficult to target so the tax may not be the most accurate amount - may be due to an information
• if placed on inelastic goods, the Qd may not fall as much unless the tax is very large
• taxes tend to be regressive - they take a larger percentage of poorer households’ incomes
• taxes are often unpopular

Question 6

what are subsidies? and why would the government apply them?

Answer 6

• subsidies are financial assistance provided by the government to encourage the production or consumption of certain goods or services
• they aim to correct market failure by promoting the provision of public goods and correct positive externalities and information failures

Question 7

what are the advantages of subsidies?

Answer 7

• subsidies can increase consumption of merit goods
• it reduces the price of a good, making it more affordable for those on lower incomes - reducing relative property
  -they can also be used to correct information failure

Question 8

what are the disadvantages of subsidies?

Answer 8

• they could be difficult to target, like taxes, a subsidy might be too large or too small
• opportunity cost of subsidies
• firms may become reliant on subsidies encouraging productive inefficiency
• if placed on products with in elastic demand, they may reduce in price but not significantly increase in consumption
• there can be conflict with other policy objectives - someone must pay those subsidies

Question 9

what are price ceilings?

Question 10

what are the advantages of a maximum price?

Question 11

what are the disadvantages of a maximum price?

Question 12

what is a price floor?

Question 13

what are the advantages of minimum prices?

Question 14

what are the disadvantages of minimum prices?

Question 15

what is involved in the government provision of public goods?

Question 16

what is the advantage of the government provision of public goods?

Question 17

what are the disadvantages of the government provision of public goods?

Question 18

what are regulations?

Question 19

what are the advantages of regulations?

Question 20

what are the disadvantages of regulations?