AS Unit 3: Government Microeconomic Intervention

Question 1

Market failure

Answer 1

When market work efficiently, they produce the best allocation of resources. As economies grow and become more complex, market failure occurs. Market failure is an inefficient allocation of goods and services in the market. The free market mechanism does not make the best use of scarce resources. Market failure occurs when the price mechanism fails to take into account all the costs and benefits needed to produce or consumer a product

Question 2

What are the 4 ways market failure occurs?

Answer 2

Lack of public goods
Underproduction of merit goods
Overconsumption of demerit goods
Information failure

Question 3

Addressing the non-provision of public goods

Answer 3

Public goods are consumed collectively and their use by one person doesn’t make it less available to others. The free rider problem means that people can enjoy a public good without contributing to its cost
It is difficult to charge for a public good. The private sector wouldn’t be interested in producing public goods as they can’t make a profit. left to the free market, they wouldn’t be provided despite their benefits. Therefore public goods have to be funded by the government out of tax revenue and are provided for free. Funding for public goods competes with other government spending

Question 4

Addressing the overconsumption of demerit goods

Answer 4

Demerit goods are undesirable for consumer and are over provided so over consumed in the free market. The main reason for this is consumers lacking full and proper information which is why government intervene in this market. Measure such as putting warning on packages protects the well-being of the population. Other reasons are to promote a more productive workforce and make healthcare savings by treating fewer people

Question 5

Addressing the underconsumption of merit goods

Answer 5

Merit goods are more beneficial for consumers than they realise. This is the result of information failure
When provided by the private sector, quantity supplied is less than required. Access is restricted to those who can afford to pay
The government could completely take over the provision of this or allow the private sector to provide some. The government would make up the difference for those unable to afford the private sectors fees

Question 6

Controlling prices in markets

Answer 6

Government set maximum prices so the seller can’t sell it legally at any price above the price ceiling. This protects those on low incomes. To be effective, it must be below equilibrium
They set minimum prices to protect suppliers incomes by raising the price above equilibrium. The government can be more certain of future supplies by consumers are worse off. Can be argues that this is an inefficient use of resources

Question 7

What is ad valorem tax?

Answer 7

A proportion of the price charged by the retailer. The final price paid by consumers includes this. Can be part of the retail price or added on

Question 8

What are specific taxes?

Answer 8

A fixed amount per unit purchased. It is based on a measurable quantity and the final price includes this

Question 9

The impact and incidence of indirect taxes

Answer 9

Indirect taxes are mainly used to discourage the consumption and production of demerit goods. They tend to be passed onto consumers through higher prices. When imposed, it must be paid to the government by retailers, wholesalers, manufacturers and other providers of taxable products. Therefore a business will require a higher price. The incidence of an indirect tax is the extent to which the tax burden is borne by the producer, consumer or both. The extent to which the producer is able to pass on the tax by raising prices depends on the PED of the product. The more inelastic it is, the easier for sellers to pass on tax as high prices. If elastic, the producer has to absorb a greater part of the tax. In emerging market economies, government feel more comfortable collecting indirect than direct taxes

Question 10

The impact and incidence of subsidies

Answer 10

Government intervention includes the provision of subsidies. These are direct payments made by governments to the producers of goods and services. When paid to a producer, a subsidy has the opposite effect of an indirect tax causing a right shift of the supply curve. The incidence of a subsidy is shared between consumers and producers. Consumers benefit from lower prices. Producers benefit from a higher price. The allocation of subsidies from limited government revenue is controversial. It interferes with the market mechanism and has opportunity cost. Subsidies come out of tax revenue

Question 11

Why are subsidies implemented?

Answer 11

To keep down the market prices of essential goods
Encourage greater consumption of merit goods
Contribute to a more equitable distribution of income
Provide services that would not be provided by the free market
Raise producers income especially in the case of farmers
Provide and opportunity for exporters to sell more goods
Reduce dependence on imports by paying subsidies to domestic producers of close substitutes

Question 12

Who benefits from a subsidy?

Answer 12

Essentials should be subsidised to provide relief for low income groups. However these prices are also paid by those who can afford more. Could be shortages. If paid to producers there is no incentive for inefficient producers to improve or that the money will be used for its intended purpose

Question 13

The direct provision of goods and services

Answer 13

Governments provide certain goods and services free of charge. They are financed through the tax system. If used equally by all citizens those on lowest incomes gain the most, lowering inequality. Most commonly the direct provision of merit and public goods. Merit goods are provided free in some economies. Sometimes there is free provision with parts being paid for at use. They can by subject to market failures but this does no justify direct provision. Public goods will not be provided by the market mechanism and consumers won’t be willing to pay. Can only be directly provided by the government out of revenue. Leads to inefficiency and higher costs. Can be overprovided. Not efficient. Demand falls with charges

Question 14

Maximum prices

Answer 14

Market failure can occur where the price of a good is too high. The government can impose a maximum price which helps people on low incomes, reduces income inequalities and recognises the wider benefits of a good. They are only valid where the maximum price is below equilibrium

Question 15

What are maximum prices used for?

Answer 15

Staple food items
Petrol and diesel fuel
Some rents
Services provided by utilities
Transport fares
Prices can’t rise so available supply has to be allocated someway. Queuing and rationing restrict demand but this leads to an informal or underground market with consumers paying inflated prices. Occurs due to dissatisfaction

Question 16

Minimum prices

Answer 16

Not very common. Only valid when set above equilibrium price. Price can’t fall so supply is restricted. Producers are likely to be inefficient. Firms with high costs have little incentive to reduce them since they are protected from low-cost competitors. Informal market may develop. In agricultural markets, the price is a living income

Question 17

What are minimum prices used for?

Answer 17

Demerit goods
Agricultural products
Wages in certain occupations to avoid employers exploiting employees
Certain imported goods where close substitutes by domestic products are available

Question 18

Buffer stock schemes

Answer 18

Designed to smooth prices rises and falls by buying and selling stocks of products. They compare to principles of maximum and minimum price controls. It starts by setting a minimum price. If market price looks like going below this the scheme will buy stocks which are stored. This action raise spices. Can also set a maximum price. This will increase supplies which will see a fall in price

Question 19

Provision of information

Answer 19

The government uses this as a form of direct intervention such as:
Compulsory information on cigarette packets warning of dangers
Public health announcements and campaigns
Advice on non-prescription medication
Nutrition and allergy information on food packages

Question 20

Income and wealth

Answer 20

Income is the reward for the services of a factor of production. For labour this is paid as wages, salaries and bonuses. For other factors it may be rent, interest and profit
Income is a flow concept because the returns to factors of production are variable
Wealth is the stock of assets that someone has built up over time. They provide security and sometimes future income

Question 21

Measuring income and wealth inequality

Answer 21

The Gni coefficient measures the extent of income inequality in an economy. If equal this will be 0. At the extreme it will be 1

Question 22

Reasons for inequalities

Answer 22

Income and wealth inequalities act as a barrier t economic growth and development
Lack of formal employment opportunities
Poor vocational training so local industries can’t obtain the labour needed to maintain a viable operation in national and international markets
Lack of investment in education and health sectors, holding back human capital for growth
Poor infrastructure
Low savings holding back private and public sector investment
Inability to obtain credit

Question 23

Policies to redistribute

Answer 23

Many of the policies depend on funds generated from tax revenue
The collection of taxes has difficulties in LIC’s and MIC’s where the informal economy is large and only a small % of the population pays direct taxes. Corruption and tax evasion are common which hinders the governments ability to successfully implement policies

Question 24

Minimum wage rates

Answer 24

This is a legal requirement of what employers must play employees. It is a rate before tax and security deductions are made
This can reduce poverty in all economies but it may only apply to a minority of workers because it may not have any impact on the informal sector. It does not work for self-employed or small-run family businesses
Could lead to unemployment since employers will be less willing to employ

Question 25

Transfer payments

Answer 25

This is a payment from tax revenue that is received by some people. They are not made through the market. Their aim is to provide a more equitable distribution of income. The main recipients are vulnerable groups:
-Old age pensions
-Unemployment benefits
-Housing allowances
-Food coupons
-Child benefits
The extent to which they are paid depends on how much tac is collected and how many people paid tax
They result in less poverty and provide a more equitable distribution of income. Unemployment benefits and benefits to those on low-incomes can act as a disincentive to accepting work, increasing unemployment. Causes inefficiency

Question 26

Progressive income taxes

Answer 26

Taxes can be used to reduce income and wealth inequalities through the use of progressive taxes, specifically progressive. This is where those earning higher incomes and taxed at a higher rate. This can be a disincentive to work or live in a high taxation country

Question 27

Inheritance tax

Answer 27

Where people who inherit more than a certain amount of wealth have to pay some of that in tax to the governemnt

Question 28

Capital tax

Answer 28

Where a tax is payable on the financial gain a person may have made in the time that the asset has been owned

Question 29

State provision of essential goods and services

Answer 29

This is financed through the tax system. If used equally by all citizens, those on lowest incomes gain the most so inequality is lowered
The main examples of this are healthcare and education
Market failure in these does not justify free provision to the consumer. Justification must be on the grounds of equity
Governments also provide goods to support those on low incomes such as food and other essential items

Question 30

Advantages of buffer stock schemes

Answer 30

Incomes ensured
Planning for businesses
Producers are more able to invest

Question 31

Disadvantages of buffer stock schemes

Answer 31

Expensive to maintain and run
Can be inefficiently managed
Won’t always work, short-term need based