4.1.8.9 Government Intervention

Question 1

The Reasons for Government Intervention in Markets

Answer 1

Reduce Market Failure:
- Reduce or eliminate negative externalities
- Reduce the Supply of demerit goods
- Increase or maximise positive externalities
- Increase the Supply of Merit Goods
- Supply Public Goods that would be undersupplied in the free market

Reduce Inequalities in the Distribution of Income and Wealth:
- Unequal Distribution can lead to poverty
- Tensions can be created in society
- A breakdown in society can cause further market failures

Governments Intervene in order to Support UK Industry:
- Full Employment as a Government Target
- Certain Industries Supply a large amount of Labour
- Infrastructure is essential if businesses are to provide quality services

Question 2

How Governments Influence the Allocation of Resources

Answer 2

Public Expenditure:
- Government Spending to pay for the needs of society such as health, education, infrastructure etc.

Taxation and Subsidies:
- Making it more expensive for products that cause high negative externalities and cheaper for those that cause positive externalities.

Regulation:
- Protecting consumers from the abuse of monopoly power that would lead to higher prices, supernormal profits and allocative inefficiency.
- Creating an environment that will encourage firms to strive for productive efficiency through reduced costs.

Question 3

Taxation Definition

Answer 3

The medium through which governments finance their spending and control the economy. It is a charge imposed on products, individuals and businesses.

Question 4

Indirect Tax Defintion

Answer 4

A tax on a good or service.

Question 5

Pigouvian Tax Definition

Answer 5

A tax designed to address market failures caused by negative externalities, where a third party experiences costs from an economic activity.

Question 6

Direct Tax Definition

Answer 6

A tax on an individual or organisation.

Question 7

Incidence of Tax Definition

Answer 7

The amount that the consumer will pay for the tax.

Question 8

Advantages of Indirect Tax

Answer 8

• High tax revenues (inelastic PED)
• Use of price mechanism (still consumer/producer choice)
• Internalise the Externality (negative externalities are priced into the decision)

Question 9

Disadvantages of Indirect Tax

Answer 9

• If inelastic, may not reduce demand sufficiently
• Hard to know correct level of tax
• Regressive Taxation
• Impact on UK firms’ international competitiveness

Question 10

Impact of Demand on Incidence of Indirect Taxes

Answer 10

Demand is inelastic, the incidence of the tax will be greater for the consumer.

Demand is elastic, the incidence of the tax will be greater for the producer.

Question 11

Impact of Supply on Incidence of Indirect Taxes

Answer 11

Supply is inelastic, the incidence of the tax will be greater for the producer.

Supply is elastic, the incidence of the tax will be greater for the consumer.

Question 12

Subsidy Definition

Answer 12

A payment made to producers to encourage increased production of a good or service.

Question 13

Impact of Subsidy

Answer 13

Lead to a decrease in the cost of supply for a firm, so a shift in the supply curve down and to the right.

Question 14

Advantages of a Subsidy

Answer 14

• Can increase consumption of merit goods
• Lower prices so more affordable for low income earners

Question 15

Disadvantages of a Subsidy

Answer 15

• Difficult to judge the size of the externality
• Opportunity cost
• Firms can become reliant on the subsidies
• Seen as artificial trade protection
• If inelastic, may not increase consumption

Question 16

Price Control Definition

Answer 16

When the government sets minimum or maximum prices for a good or service.

Question 17

Advantages of Minimum Prices

Answer 17

• Producers get a minimum guaranteed price
• Encourage production of essential goods
• Excess supplies can be stored

Question 18

Disadvantages of Minimum Prices

Answer 18

• Consumers may pay a high price
• Can encourage over-production
• Opportunity cost of Government expenditure
• Reduce international competitiveness
• May encourage consumers to seek cheaper, more harmful alternatives

Question 19

Advantages of Maximum Prices

Answer 19

• Allow less well off people to afford necessities
• Lessen monopoly power to exploit consumers

Question 20

Disadvantages of Maximum Prices

Answer 20

• May create an excess of demand - some people unable to access product/service
• Excess demand = queues, shortages and waiting lists
• Black markets may appear

Question 21

State Provision Definition

Answer 21

When goods and services are either merit goods or public goods, the government will intervene to ensure that an adequate supply of these products is available to the market.

Question 22

Advantages of State Provision

Answer 22

• Individuals do not have to worry about paying at point of consumption
• Could improve equality
• Can match government objectives

Question 23

Disadvantages of State Provision

Answer 23

• Opportunity cost
• Government may not have sufficient information

Question 24

Regulation Definition

Answer 24

When the government seeks to provide effective competition within markets.

Question 25

Advantages of Regulation

Answer 25

- Helps consumers to make better decisions

Question 26

Disadvantages of Regulation

Answer 26

- Interference from the “nanny state” - Suppliers may find a way around the legislation

Question 27

Methods of Correcting Information Failures

Answer 27

- Clearer labelling - Campaigns to Raise Awareness - Health Warnings - League Tables - More Open Reporting

Question 28

Advantages of Correcting Information Failure

Answer 28

- Less costly solution - Targeted at specific individuals/groups

Question 29

Disadvantages of Correcting Information Failure

Answer 29

- Opportunity Cost - Effectiveness - Opposing effect of companies - Clarity of problem/solution

Question 30

Advantages of Extending Property Rights

Answer 30

- Uses the market mechanism to ensure an efficient use of resources - An increase in knowledge and expertise for the organisation with the property right. It takes away pressure from the government to assess the pollution. - Greater likelihood that the ‘property’ will be managed carefully to ensure its availability for the future - Property owners can charge firms that need to pollute the environment

Question 31

Disadvantages of Extending Property Rights

Answer 31

- Difficult for a government to extend property rights - It could be difficult to trace the source of environmental damage - Legal costs involved in prosecuting a polluter could be extremely high which may deter victims from taking action

Question 32

What are Pollution Permits

Answer 32

Involve giving firms the legal right to pollute a certain amount e.g. 100 units of CO2 a year. If the firm produces less pollution it can sell its pollution permits to other firms. If the firm produces more pollution it has to buy permits from other firms or the government.

Question 33

Aim of Pollution Permits

Answer 33

To provide market incentives to firms to reduce pollution and to reduce the external costs associated with it.

Question 34

Disadvantages of Pollution Permits

Answer 34

- Difficult to know correct number of permits to give out - Can be difficult to measure pollution levels. There is potential for hiding pollution levels or shifting production to other countries, with looser environmental standards - Admin Costs - Rich Developed Countries can simply buy permits from less developed countries - Biggest carbon trading scheme is the EU Emissions Trading Scheme, however political interference has created a glut of permits and seems to be ineffective - Environmentalists have argued a higher price of carbon is insufficient to reduce carbon dioxide to levels necessary to stop global warming. Price inelastic demand. - Some carbon trading schemes have a component called ‘carbon offsetting’