Chapter 3

Question 1

What is meant by government intervention in a microeconomy?

Answer 1

It refers to actions taken by the government to correct market failures, improve economic welfare, and regulate the allocation of resources when the market alone fails to achieve efficiency.

Question 2

Why Do Governments Intervene?

Answer 2

Correct market failure

Redistribute income and wealth

Provide public goods

Internalize externalities

Promote equity and efficiency

Stabilize markets

Question 3

What are common types of market failure requiring intervention?

Answer 3

Externalities (positive/negative)

Public goods (non-rival, non-excludable)

Information failure

Monopoly power

Factor immobility

Under-provision of merit goods & over-provision of demerit goods

Question 4

How do indirect taxes work in microeconomic intervention?

Answer 4

Increase cost of producing/consuming harmful goods (e.g. tobacco)
Also, Raises government revenue

Question 5

What is the purpose of a subsidy?

Answer 5

Encourages production/consumption of merit goods or positive externalities (e.g. education)

Reduces price and increases quantity

Opportunity cost of public funds

May lead to inefficiency or overuse

Question 6

Purpose and effects of a price ceiling?

Answer 6

-Keeps essential goods affordable (e.g. rent control)
- leads to excess demand (shortage)
-May cause black markets or reduced qualit

Question 7

When is a price floor used and what are its effects?
A:

Answer 7

Supports producers (e.g. minimum wage)

Leads to excess supply (unemployment/surplus)

May need gov’t to purchase or store surplus

🖍️ Diagram: Price floor above equilibrium

Question 8

How does regulation influence market behavior?

Answer 8

Sets rules/limits (e.g., emission standards, legal age for consumption)

Reduces negative externalities or protects consumers

Can be expensive to enforce and hard to monitor

Question 9

Why does the government directly provide some goods?

Answer 9

Public/merit goods may be under-provided (e.g., education, health)

Ensures universal access

Can be inefficient and costly

Question 10

What are tradeable pollution permits?

Answer 10

Allow a fixed level of emissions

Firms can buy/sell unused permits

Provides incentive to pollute less

Creates market for pollution control

Question 11

How do governments tackle information failure?

Answer 11

Awareness campaigns (e.g. anti-smoking ads)

Mandatory labeling (e.g., calories on food)

Helps consumers make informed choices

Question 12

What is government failure in microeconomics?

Answer 12

When intervention worsens the situation
Causes:

Poor information

High admin costs

Unintended consequences

Political motives

Regulatory capture

Question 13

Define the difference between income and wealth inequality.

Answer 13

Income inequality: Unequal distribution of earnings.

Wealth inequality: Unequal ownership of assets (property, investments, etc.)

Question 14

How does progressive tax reduce inequality?

Answer 14

Higher earners pay a higher % of income

Redistributes income through government spending
HOWEVER,
Can reduce incentives to work/invest if too high

Question 15

What are transfer payments?

Answer 15

Welfare payments (e.g. pensions, unemployment benefits)

Non-contributory; aimed at low-income households
IT
Improves equity but costly and may reduce work incentives

Question 16

How does a minimum wage affect income distribution?

Answer 16

Raises wages for lowest earners

May cause unemployment if set too high

Helps reduce working poverty

Question 17

How does public service provision reduce inequality?

Answer 17

Free/subsidized health and education

Increases social mobility and productivity

Reduces income disparities in the long run

Question 18

What are the pros of policies tackling inequality?

Answer 18

✅ Improves equity, social cohesion
✅ Increases access to essentials

Question 19

What are the cons of policies tackling inequality?

Answer 19

❌ Potential disincentives to work
❌ High fiscal burden on government
❌ Potential government failure

Question 20

Q: How does intervention aim to improve allocative efficiency?

Answer 20

A:
By aligning marginal social benefit (MSB) and marginal social cost (MSC) through policy tools like taxes, subsidies, and regulations, ensuring optimal resource use and welfare maximization.

Question 21

Q: What is factor immobility and how does it justify intervention?

Answer 21

A:

Occurs when land, labor, or capital can’t easily move between uses.

Causes underemployment and inefficiency.

Government may retrain labor or invest in infrastructure.

Question 22

Why are merit and demerit goods linked to intervention?

Answer 22

A:

Merit goods (e.g. vaccinations) are underconsumed without gov’t help.

Demerit goods (e.g. alcohol) are overconsumed due to info failure.

Intervention ensures socially optimal levels of consumption.

Question 23

: Differentiate between equity and equality in microeconomics.

Answer 23

A:

Equality: Everyone receives the same.

Equity: Resources distributed based on need or fairness.

Gov’t intervenes to improve equity, not necessarily equality.

Question 24

What are price stabilization schemes?

Answer 24

A:

Used in volatile markets (e.g. agriculture).

Gov’t intervenes to prevent sharp fluctuations in price.

Can involve buffer stock schemes or guaranteed minimum prices.

Question 25

Q: What is the role of PPPs in micro intervention?

Answer 25

A: Joint ventures between gov’t and private firms to deliver public services. Brings efficiency of private sector + social goals of gov’t.

Question 26

How do nationalization and privatization impact market outcomes?

Answer 26

A: Nationalization: Gov’t ownership to serve public interest Privatization: Encourages efficiency through competition Both affect allocative/productive efficiency, depending on context

Question 27

: How does behavioral economics shape modern intervention?

Answer 27

A: Governments use nudges (e.g., default pension enrollment) Tries to alter behavior without coercion Complements traditional methods (e.g., tax)

Question 28

How do indirect taxes address micro failures?

Answer 28

A: Internalize negative externalities Raises private cost = social cost Example: carbon tax, sugar tax Evaluation: regressive, cost of compliance, hard to set optimal level

Question 29

Q: When are subsidies effective in microeconomics?

Answer 29

A: Encourage merit goods/positive externalities Increase consumption/production Diagram: supply shifts right Evaluation: cost burden, risk of inefficiency, hard to target

Question 30

How do price controls impact microeconomic markets?

Answer 30

A: Price ceiling (below equilibrium): helps consumers, causes shortages Price floor (above equilibrium): supports producers, causes surpluses Examples: rent control, minimum wage Evaluation: creates secondary markets, inefficiency

Question 31

What is a public good and why is it non-provided in markets?

Answer 31

A: Non-excludable and non-rivalrous (e.g., street lights, defense). Market failure because private firms can’t charge for use, leading to free rider problem. Solution: Government provision

Question 31

why are demerit goods overconsumed?

Answer 31

A: Imperfect information (e.g., cigarettes, alcohol). People underestimate harm (negative externalities). Government intervention: taxes, regulations, bans, info campaigns.

Question 32

Q: Why are merit goods underconsumed? A:

Answer 32

Consumers don’t realize full personal or social benefits (e.g., healthcare, education). Government intervention: subsidies, direct provision, compulsory use.

Question 33

What is the purpose of price controls? A:

Answer 33

Maximum Price (Price Ceiling) = below equilibrium: Makes goods affordable but causes shortages. Minimum Price (Price Floor) = above equilibrium: Supports producers but causes surpluses.

Question 34

How do indirect taxes affect markets?

Answer 34

A: Raise production costs: Shifts supply curve left. Purpose: Internalize negative externalities (e.g., carbon tax). Incidence of tax: Depends on elasticity (inelastic = consumers bear more

Question 35

Q: What do subsidies do in markets?

Answer 35

A: Reduce production costs: Shifts supply curve right. Encourage positive externalities (e.g., renewable energy). Incidence of subsidy: Depends on elasticity (more elastic supply = bigger response).

Question 36

hy does the government directly provide goods and services? A:

Answer 36

To ensure accessibility and correct under-consumption of merit goods (e.g., healthcare, education). Example: Free/subsidized healthcare and education.

Question 37

Q: How does the provision of information help correct market failure?

Answer 37

A: Corrects information failure (e.g., health warnings on cigarettes). Changes consumer behavior and increases social welfare.

Question 38

Q: What is a buffer stock scheme and its purpose?

Answer 38

A: Government buys surplus goods (e.g., agricultural) during high production. Releases stocks when supply is low, to stabilize prices. Risk: Storage costs, mismanagement.

Question 39

What’s the difference between income and wealth?

Answer 39

A: Income = flow (money received regularly, e.g., wages). Wealth = stock (assets held at a point in time, e.g., property, shares)

Question 40

: What does the Gini coefficient measure? .

Answer 40

A: Income/wealth inequality: Scale of 0 (perfect equality) to 1 (perfect inequality). Higher Gini = higher inequality

Question 41

What causes income and wealth inequality?

Answer 41

A: Differences in education, skills, and productivity. Inheritance of wealth. Access to capital markets, discrimination, ownership of resources.

Question 42

How does the minimum wage impact inequality?

Answer 42

A: Ensures a living wage for workers. May cause unemployment if set too high, creating labour surplus.

Question 43

What are transfer payments and their role in inequality?

Answer 43

A: Welfare benefits (e.g., unemployment benefits). Raise disposable income for low-income earners. Risk of dependency.

Question 44

Q: How do progressive taxes help redistribute wealth?

Answer 44

A: Higher income = higher tax rate. Reduces wealth concentration. Risk: May reduce incentives to work or invest.

Question 45

What’s the role of inheritance and capital taxes in inequality?

Answer 45

A: Tax on wealth transfer or investment returns. Helps reduce long-term wealth gaps. Can discourage saving and investment.

Question 46

Why does the government provide essential goods/services?

Answer 46

A: Reduces inequality of opportunity (e.g., free education). Ensures basic needs (healthcare, housing). Risk: High cost, inefficiency.

Question 47

What does incidence refer to in taxes and subsidies?

Answer 47

A: Incidence: Who bears the burden of the tax or benefits from the subsidy. Depends on elasticity: Inelastic demand → consumers bear most of tax. Elastic supply → producers bear most of subsidy.

Question 48

Q: Summarize government intervention in markets. REASON? METHOD? OUTCOME? RISK?

Answer 48

: Reasons for intervention: Correct market failure (public goods, demerit/merit goods, inequality). Methods: Taxes, subsidies, direct provision, price controls, buffer stocks. Outcome: Aims to improve efficiency, equity, and reduce market failure. Evaluation: Intervention can have unintended consequences and government failure.