2.11 Government intervention to correct market failure Flashcards
The role of markets (32 cards)
What are the main areas of market failure?
- Externalities
- Merit and demerit goods
- Information failure
- Public goods
- Lack of competition
What is tax?
Compulsory charges imposed by governments on individuals and firms
What’s a direct tax?
Tax placed on the income of people and firms e.g. income tax, corporation tax
What’s an indirect tax?
Tax places on goods and services e.g. VAT
What would an indirect tax diagram look like?
Links to negative production externalities diagram
Supply would shift to the left from S to S + tax. The effect is to reduce the quantity firms are willing to supply at any given price. If the original price was P0 and the new price is P1, buyers are paying (P1-P0) x Q1 extra. However as Q shifts from Q0 to Q1, there’s also the price of P1-tax from the original supply of S so the tax payed by the seller is P0 - (P1-tax) x Q1. The full size of the tax being P1 - (P1-tax). The total tax revenue the gov. receives would be P1 - (P1-tax) x Q1.
(Buyer above, seller bellow)
Who pays more of the tax if the demand is inelastic?
Consumer
Who pays more of the tax if the demand is elastic?
Producer
Advantages of indirect taxation
- Works with the market through supply and demand
- Can internalise negative externalities (producer is required to pay the tax in full)
- Can force payment on the polluter
- Tax revenue can be used by gov. to fund merit and public goods
Disadvantages of indiect taxation
- Difficult to determine the amount of tax
- PED of many demerit goods is inelastic meaning tax may not have the intended effect
- How do we monitor if it’s payed or not
What are subsidies?
A payment from the government to the producers of goods and services. The purpose being to reduce cost/price in order to encourage higher level of production/consumption
What would a subsidy diagram look like?
Links to positive consumption/production externalities diagrams
Supply shifts to the right from S to S+subsidy because firms face lower costs to produce therefore can produce more. If the original price was P1 and increased to P3 before the subsidy, the producer receives that price (P3-P1) but also as Q1 shifts and increases to Q2, P2 would be the price paid after the subsidy so P1 to P2 is the price the consumer then pays (P1-P2)
(Producer above, consumer below)
Examples of government expenditure and state provision
- Funding/subsidising merit goods
- Funding public goods
- Funding infrastructure projects
- Redistribution of income
Advantages of state funding/provision
- Increases social welfare when markets are missing (public goods)
- Overcome market failure associated with merit goods (increasing consumption of merit goods to increase social welfare)
- Overcome market failure associated with goods that result in positive externalities
Disadvantages of state funding/provision
- May be expensive and impose an opportunity cost
- Lack of market incentives may reduce worker efficiency
- Lack of market signals may mean gov. has inadequate information on consumer preferences
What’s a public-private partnership?
Gov. service/private business venture is funded/operated through a partnership of government and the private sector
What’s the private finance initiative (PFI)?
Encourages private investors to manage the build and operation of public infrastructure
Advantages of PFI
- Efficient (private sector is better at managing investment projects than public sector)
- Extra investment (PFI provides private sector funds for projects that might prove difficult for the gov. to finance, will increase productive capacity and economic growth)
Disadvantages of PFI
- Debt costs (cost of private sector finance has increased over time)
- Risk (no guarantee the private sector will make a better cost benefit analysis of a project than the public sector)
Regulation of price/price controls (a maximum price aim)
To enable those on low incomes to afford something which is a necessity
Maximum price diagram
Pmax horizontal line is underneath the P equilibrium. Gov. impose maximum level of something that firms can charge their consumers. This will cause supply to reduce from Q to Qs. At this lower price, more people will be looking for the good so demand will increase to Qd. Problem is the market’s in disequilibrium in fact making the situation worse - Qs being less could result in e.g. more homelessness if about housing
Minimum price diagram
Pmin horizontal line is above the P equilibrium. Suppliers are willing to supply more at this high price - the market is in disequilibrium with this excess supply. Perhaps scarce resources will not be allocated to the overproduction of something that will not be sold at the higher price which is inefficient
Maximum price advantages and disadvantages
+ Helps increase fairness
- Demand higher than supply
- Gov. may need to introduce a rationing scheme
Minimum price advantages and disadvantages
+ Producers have a guaranteed minimum income which will encourage investment
- Consumers pay higher price
- Resources used to produce excess supply could be used elsewhere
What is legislation?
Laws that are enacted by the governing body
