2.11 Government Intervention

Question 1

Why do governments intervene in the market

Answer 1

To correct market failure

For example, they might provide healthcare and education

Question 2

What are indirect taxes and what do they do

Answer 2

They are taxes on expenditure. They increase production costs for producers, so they supply less. This increases market price and demand contracts. They can be used to discourage the production or consumption of cigarettes

Question 3

What are the two types of indirect taxes

Answer 3

Ad valorem

Specific taxes

Question 4

What are ad valorems

Answer 4

They are percentages, such as VAT, which adds 20% of the unit price. This is the main indirect tax in the UK

Question 5

Describe what an ad valorem diagram looks like

Answer 5

Question 6

Explain the ad valorem diagram

Answer 6

The incidence of tax might fall differently on consumers and producers. Producers could make consumers pay the whole tax, but if they feel this would lower sales, they may choose to pay some of the tax.

Question 7

What does the incidence of the tax depend on

Answer 7

The price elasticity of the good. A more price inelastic good wouod mean the consumers might have the larger burden of tax. This should discourage the consumption of the demerit good and reduce negative externalities

Question 8

What is a specific tax

Answer 8

A set tax per unit

Question 9

Describe how a specific tax diagram looks

Answer 9

Question 10

What effect does a good with a more inelastic demand have on specific taxes

Answer 10

The more inelastic the demand, the higher the tax burden for the conusmer, and the lower the burden of tax for the producer

Question 11

How can indirect taxes reduce the quantity of demerit goods consumed

Answer 11

By increasing the price of the good. If the tax is equal to the external cost of each unit, then the free market equilibrium becomes the socially optimum. This means the polluter pays for the damage

Question 12

What is a subsidy

Answer 12

A payment from the government to a producer to lower their costs of production and encourage them to produce more

Question 13

What do subsidies encourage

Answer 13

The consumption of merit goods. This includes the full social benefit in the market price of the good

Question 14

Give an example of a subsidy

Answer 14

The government might subsidise recycling schemes so it is cheaper for consumers to recycle waste, which gives positive externalities for the environment

Question 15

What does a subsidy graph look like

Answer 15

Question 16

What happens the the supply curve after a subsidy

Answer 16

The supply curve shifts to the right

Question 17

What on a subsidy graph shows the value of the subsidy per unit

Answer 17

The vertical distance between the supply curves

Question 18

When do the consumers and producers gain more from a subsidy

Answer 18

Consumers gain more when demand is price inelastic, whilst producers supply more when demand is price elastic

Question 19

What are the disadvantages of subsidies

Answer 19

The opportunity cost to the government and potentially higher taxes, the potential for firms to become inefficient if they rely on the subsidy and government failure, if they subsidise less efficient industries

Question 20

What is a maximum price

Answer 20

The government might set a maximum price where the consumption or production of a good is to be encouraged. This is so that the good does not become too expensive to produce or consume

Question 21

Where do maximum prices have to be set

Answer 21

Below the free market price, otherwise they would be ineffective

Question 22

What does a maximum price diagram look like

Answer 22

Question 23

What do maximum prices prevent

Answer 23

They prevent monopolies exploiting consumers

Question 24

What do maximum prices control

Answer 24

They control the market price, but this could lead to government failure if they misjudge where the optimum market price should be

Question 25

What can maximum prices lead to

Answer 25

Welfar gains for consumers by keeping prices low, and they could increase efficiency in firms, since they have an incentive to keep their costs low

Question 26

What could a maximum price do to firms profits

Answer 26

It could reduce then which could lead to less investment in the long term

Question 27

What is a minimum price

Answer 27

Where the consumption ir production of a good is to be discouraged by ensuring the good never falls below a certain price

Question 28

Give an example of where minimum price is used

Answer 28

The government might impose a minimum price on alcohol, so it is less affordable to buy The national minimum wage is another example

Question 29

What do minimum prices reduce

Answer 29

They reduce the negative externalities from consuming a demerit good, such as alcohol

Question 30

Where do minimum prices have to be set

Answer 30

They must be set above the free market price otherwise they would be ineffective

Question 31

What does a minimum price diagram look like

Answer 31

Question 32

Explain a minimum price diagram with the example of a national minimum wage

Answer 32

The diagram suggests that a minimum wage leads to a fall in the employment rate. It does depend on what level the wage is set. An inelastic labour demand will mean there is only a small contraction in demand for labour

Question 33

In which market is a buffer stock system usually used

Answer 33

This is mainly in agricultural markets, where prices are volitile

Question 34

Why might a government use a buffer stock system

Answer 34

In order to smooth out these fluctuations

Question 35

How do the government implement a buffer stock system

Answer 35

Governments buy up harvests during surpluses, then sell the goods onto the market when supplies are low

Question 36

Advantages on a buffer stock system

Answer 36

Farmer income remains stable because fluctuations are reduced Benefits rural areas where farming is a main source of income Increases consumer welfare by ensuring prices are not in excess

Question 37

Disadvantages of a buffer stock system

Answer 37

Governments may not have the financial resources to buy up stock By guaranteeing minimum prices farmers may over produce which can be expensive and damaging to the environment Storage can be difficult and expensive

Question 38

What are regulations

Answer 38

The government might use laws to ban consumers from consuming a good. They could also make it illegal not to do something

Question 39

Give an example of a regulation

Answer 39

The minimum school leaving age means young people have to be in school until the age of 16, and education or training until they turn 18.

Question 40

What is a benefit from a regulation on minimum school leaving age

Answer 40

There are positive externalities in the form of a higher skilled workforce

Question 41

What are the effects of regulations on firms

Answer 41

It could raise costs of firms, who might pass on the higher costs to consumers Firms which fail to follow regulations could face heavy fines

Question 42

What is a tradeable pollution permit

Answer 42

Something that allows firms to pollute up to a certain amount, and any surplus on their permit can be traded

Question 43

What are benefits of tradeable pollution permits

Answer 43

They could limit the amount of negative externalities, in the form of pollution, created by industies

Question 44

Advantages on tradebale pollution permits

Answer 44

Benefits the environment in the long run by encouraging firms to be greener Governments can raise revenure by selling permits which can be reinvested in green technology

Question 45

Disadvantages of tradeable pollution permits

Answer 45

Some firms may relocate to where they can pollute whitout limits Firms might pass higher costs of production onto the consumer Can be expensive for governments to monitor emissions

Question 46

What is state provision of public goods

Answer 46

The government could provide public goods which are underprovided in the free market, such as education and healthcare

Question 47

Benefits of state provision of public goods

Answer 47

This makes merit goods more accessible, which might increase their consumption and yield positive externalities

Question 48

Drawback of state provision of public goods

Answer 48

It could be expensive for governments to provide education, and the government will incur an opportunity cost of spending their revenue

Question 49

What is provision of information

Answer 49

By providing information, governments can ensure there is no information failure, so consumers and firms can make informed economic decisions

Question 50

What is government intervention

Answer 50

When the government intervenes in a market economy. The market is controlled by both the government and the forces of supply and demand. Governments often provide public goods such as streets lights, roads and the police, as well as merit goods, such as healthcare and education

Question 51

How can government intervention fail

Answer 51

Governments can fail when they intervene in markets. They could worsen the market failure already present or a new failure might occur. This results in a net welfare loss to society

Question 52

Advantages of government intervention

Answer 52

Might be easier to coordinate resources in times of crisis Government can compensate for market faikure by reallocating resources Reduce inequality in society

Question 53

Disadvantages of government intervention

Answer 53

Governments fail as they may not be fully informed for what to produce They may not meet consumer preferences

Question 54

What are the causes of government failure

Answer 54

Distortion of price signals Unintended consequences Excessive administrative costs Information gaps

Question 55

What is meant by distortion of price signals

Answer 55

Government subsidies could distort price signals by distoring the free market mechanism. For example, the government may end up subsidising an industry which is failing or has few prospects

Question 56

What is meant by unintended consequences

Answer 56

This is when actions of producers and consumers have unexpected, or unintended consequences. With government policies, consumers act in unexpected ways For example, a policy could be undermined, which could make government policies expensive to implement

Question 57

What is meant by excessive administrative costs

Answer 57

The social benefit of a policy might not be worth the financial cost of administering the policy. The government have to consider whether the policy is good value for money

Question 58

What is meant by information gaps

Answer 58

Some policies might be decided without perfect information. They may require a full cost-benefit analysis which could be time-consuming and expensive. It is not possible to know every but of information so some assumptions have to be made