1.4.1 - government intervention in markets

Question 1

What is the aim of indirect taxes?

Answer 1

Indirect taxes aim to internalise the externality by moving the market equilibrium closer to the social optimum and eliminating dead-weight welfare loss

Question 2

What incentive do indirect taxes provide?

Answer 2

Provides an incentive to reduce production

Question 3

How do indirect taxes benefit the government financially?

Answer 3

A source revenue for the government to reduce administration costs. This may help goods to become elastic in the long-run, though the effect will depend on how the government spends their revenue

Question 4

Why is it hard to set the correct indirect tax level?

Answer 4

As it is difficult to work out the size of the externality as it tends to be placed on value judgements, since it is difficult to monetise external costs, therefore also hard to identify how much to tax.

Question 5

What does the effectiveness of indirect taxes depend on?

Answer 5

Its effectiveness depends on the price elasticity of demand for the good

Question 6

Why are indirect taxes considered regressive?

Answer 6

They are regressive as those with a higher income spend a lower proportion of their income in indirect taxes than those with a lower income

Question 7

What is the aim of subsidies?

Answer 7

Subsidies aim to increase market equilibrium quantity to match that of the social optimum

Question 8

How do subsidies affect consumption and firms?

Answer 8

Provides an incentive to increase consumption as reduces costs of production for firms, this can have other positive impacts, such as encouraging small businesses, bringing about equality and encouraging exports

Question 9

What is a drawback of subsidies for taxpayers?

Answer 9

There is a cost to the taxpayer providing subsidies

Question 10

Why is it difficult to determine the right subsidy amount?

Answer 10

As it is difficult to work out the size of the externality as it tends to be placed on value judgements, since it is difficult to monetise external costs, therefore also hard to identify how much to subsidies

Question 11

What does the effectiveness of subsidies depend on?

Answer 11

Its effectiveness depends on the price elasticity of demand for the good

Question 12

What happens once subsidies are introduced?

Answer 12

Once introduced they are difficult to remove

Question 13

What is the opportunity cost of subsidies?

Answer 13

Creates and opportunity cost for other government expenses

Question 14

What are tradeable pollution permits?

Answer 14

Tradeable pollution permits are a mechanism used to regulate pollution using market forces.

Question 15

What is carbon trading?

Answer 15

Carbon trading is a form of pollution control that uses the market mechanism to change relative prices and the incentives of producers and consumers to reduce their total carbon emissions.

Question 16

How do carbon permits work in a cap-and-trade system?

Answer 16

One way this occurs is by creating market for carbon permits (cap-and-trade system), which give companies the right to pollute up to a certain amount. The government controls how many permits so limits the maximum amount of pollution. As they can be traded on the market, companies that need to pollute more can buy permits from companies that don’t need to use all their allotted pollution allowance. The fixed supply of permits is capped and gradually reduced which leads to a higher price.

Question 17

What incentive do tradeable permits create?

Answer 17

Consequently, this system creates and incentive for companies to reduce their pollution, as they make revenue from selling their unused pollution permits and to reduce costs of production since an increase in demand will significantly increases the price of permit due to the fixed supply of permits

Question 18

How do tradeable permits guarantee emission reductions?

Answer 18

Guaranteed that pollution will fall to the targets set by the government as they cap the number of permits

Question 19

What is a limitation of the pollution permit system?

Answer 19

However, it doesn’t completely eradicate pollution and produces a risk of larger firms purchasing many permits so they can continue to pollute.

Question 20

What are the operational difficulties of the permit scheme?

Answer 20

It is also expensive and difficult for governments to operate this scheme since they don’t know how many permits they should allow, creating an opportunity cost for other government expenses.

Question 21

How might pollution permits affect businesses and consumers?

Answer 21

It will raise the costs for businesses, and is likely that they will be passed onto the consumers

Question 22

What is another form of carbon trading besides permits?

Answer 22

Another form of carbon trading is a carbon tax on carbon emissions, which is an indirect tax on producers that raisers the price of emissions. Though it mandates a specific price on carbon, it carries the limitation of an indirect tax.

Question 23

What is a maximum price?

Answer 23

Maximum prices is a legally impose price for a good that the suppliers can’t charge above. They are set on goods with positive externalities

Question 24

When must a maximum price be set to be effective?

Answer 24

For it to have an effect it must be set below the current price equilibrium.

Question 25

What are benefits of maximum prices for consumers?

Answer 25

This enables consumers on low incomes to be able to afford a product whilst preventing increases in inflation and preventing monolopies from exploiting consumers, increasing equality

Question 26

What is a potential downside of maximum prices?

Answer 26

There is a danger that shortages result in some people being unable to purchase the product since there is excess demand

Question 27

Why might producers exit the market under maximum prices?

Answer 27

Producers might exit market to produce something which makes more profit, or if the government subsidises firms to ensure they continue producing, there is a cost to the taxpayer to fund the subsidy

Question 28

What black market risk comes with maximum prices?

Answer 28

May also lead to illegal bribes or discriminatory policies in allocating goods

Question 29

What is a minimum price?

Answer 29

Minimum prices is a legally imposed price at which the price of the good can’t go below. They are set on goods with negative externalities, so that the price is raised to the social optimum level and consumption is discouraged

Question 30

When must a minimum price be set to be effective?

Answer 30

For it to have an effect it must be set above the current price equilibrium

Question 31

What benefit does minimum price offer producers?

Answer 31

This means producers know in advance the price they will receive, allowing them to plan investment and output, increasing equality

Question 32

What risk comes from surpluses under minimum pricing?

Answer 32

There is a danger that surpluses can cause inefficient resource allocation since there is excess supply, and there is a cost to the taxpayer for the cost of storage.

Question 33

What happens under a legal minimum price system?

Answer 33

Suppliers can’t sell all their goods at the higher price, so they end up with unsold surplus. To avoid losses, they reduce supply, which lowers output and can lead to job cuts.

Question 34

What happens under a guaranteed minimum price system?

Answer 34

The government buys the surplus at the set price, which is expensive and takes money away from other things. The extra goods then need to be stored, resold, or destroyed, adding more costs.

Question 35

What if a minimum price is set too high?

Answer 35

If the minimum price is set too high, there would be an annual surplus

Question 36

Why is it hard for governments to set prices correctly?

Answer 36

It is difficult for the government to know where to set the prices, as it is difficult to work out the size of the externality and because it will have implications on the size of excess supply/demand. Both can also lead to the creation of black markets.

Question 37

What is state provision of public goods?

Answer 37

State provision of public goods is when the government uses tax revenue to pay for the provision of public goods

Question 38

How does state provision of public goods address market failure?

Answer 38

Corrects market failure and improving social welfare as it provides goods which would otherwise not be provided and ensures everyone has access to basic goods. The provided goods themselves can also carry economic benefits

Question 39

What is the opportunity cost of public goods provision?

Answer 39

However, there is an opportunity cost surrounding the spending on public goods and decisions are made by government officials on how these resources are allocated

Question 40

Why might government provision be inefficient?

Answer 40

This is especially because the market is not involved and the government may be inefficient at production since they have no incentive to cut costs, meaning they may produce the wrong combination of goods.

Question 41

What political issues can affect public good provision?

Answer 41

Government officials also may suffer from corruption and conflicting objectives

Question 42

What is the aim of government provision of information?

Answer 42

Provision of information by governments to close information gaps, though there is no guarantee that that compaigns will work and there is a cost associated with such campaigns. It is therefore best if the government uses this alongside other policies.

Question 43

What are regulations by governments?

Answer 43

Regulation by governments involve legal restrictions which can be placed on either the consumers or producers, which should in theory restrict activity to the required level.

Question 44

What benefit can regulation bring?

Answer 44

This should limit the extent of the activity and might act as an incentive for firms to develop new technology.

Question 45

What issues can arise with regulation?

Answer 45

However, the government faces issues such as the cost of enforcement, problems with determining socially optimal levels and black market issues.

Question 46

How can excessive regulation harm markets?

Answer 46

Excessive regulation may reduce competition in a market and efficiency, by increasing bureaucracy and reducing innovation