1.4.1 Government intervention in Markets

Question 1

Give 3 reasons for governments to intervene markets

Answer 1

• To correct market failure
• To improve the performance of UK economy
• To address politically and morally wrong situations, i.e. providing free healthcare etc.

Question 2

How can government intervention lead to an increase in economic welfare?

Answer 2

By taxing a good with negative externalities, they will force companies to work at a level that is socially optimum. This is better as the firms in question don’t overproduce the good.

Question 3

Name the 4 main methods of governments to intervene in markets.

Answer 3

• Price control
• Regulations and legislations
• Direct provision
• Taxes and subsidies

Question 4

Name 3 types of price control

Answer 4

• Minimum price
• Maximum price
• Buffer stocks

Question 5

Explain how minimum prices work

Answer 5

A minimum price is set above the market equilibrium so it encourages producers to produce more of the product aiming to lessen the excess demand. However this can lead to excess supply that the government has to store.

Question 6

Explain how maximum prices work

Answer 6

A maximum price has to be set below the price equilibrium for it to be effective as it acts like a price ceiling meaning that all prices have to be below this. This creates excess demand for consumers but it could put some producers off entering the market as they would be selling one unit for much less.

Question 7

Explain how buffer stocks work

Answer 7

This is introduced into markets that have volatile prices i.e. farming to ensure that there is a price ceiling and a price floor, containing the price. This means that farmers are ensured that they can make a consistent profit from their good and therefore produce more.

Question 8

What are the advantages and disadvantages of buffer stock schemes?

Answer 8

Advantages:
- Keeps income stable
- Encourages investment
- Keeps employment stable
Disadvantages:
- The cost of storing products is high and some goods could be perishable
- Most schemes break down in the long-run
- The price floor is often too high meaning that goods are often not sold and then perish.

Question 9

Give 4 examples of government regulation

Answer 9

• Age restrictions on alcohol drinking and purchasing.
• Total bans, making the good illegal
• Including designated areas (smoking)
• Health warnings on goods.

Question 10

Give 2 reasons for direct provision of goods by the government.

Answer 10

• If the good is a public good or quasi public and is not provided by the market.
• If the good is a ‘human right’ such as education and health then it is provided by the government.

Question 11

What could be an appropriate intervention for a merit good?

Answer 11

Subsidise the producers so they don’t have to pass on the higher cost of production through the good.

Question 12

What could be an appropriate intervention for a demerit good?

Answer 12

Minimum Price

Question 13

What could be an appropriate intervention for a negative externality in production?

Answer 13

An indirect tax

Question 14

What could be an appropriate intervention for a positive externality in production?

Answer 14

A subsidy

Question 15

What could be an appropriate intervention for an asymmetry in information?

Answer 15

Regulations around the provision of information through packaging.

Question 16

What could be an appropriate intervention for a public good?

Answer 16

Direct provision

Question 17

How do pollution permits work?

Answer 17

Each firm has an allowance of how much pollution they produce and if they exceed this then they have to pay a fine.

Question 18

What is meant by internalising an externality?

Answer 18

This is where the the cost of this externality is passed on to the consumer and the producer involved in the transaction so no 3rd parties have to suffer the consequences and the externality is internalised.