Government Failure

Question 1

Government intervention

Answer 1

Any (regulatory) action carried out by the government that affects the market with the objective of changing the free market equilibrium / outcome.

Question 2

Government interventions in markets

Answer 2

1) Indirect taxation (ad valorem and specific)
2) Subsidies
3) Max and Min prices

Question 3

Indirect taxation types

Answer 3

Ad valorem: tax based on the value of the item
Specific: tax of a fixed amount regardless of its value

Question 4

Subsidies

Answer 4

Represent payments by the government to suppliers that have the effect of reducing their costs and encouraging them to increase output
- effect of a government subsidy

Question 5

Maximum and Minimum prices

Answer 5

Max: legally imposed price for a good that the suppliers cannot charge above e.g. food as a shortage will negatively impact NHS
Min: legally imposed price at which the price of the good cannot go below e.g. goods with negative externalities so the price is raised to social optimum point and consumption is discouraged

Question 6

Other methods of government intervention

Answer 6

• trade pollution permits
• state provision of public goods
• provision of information
• regulation

Question 7

Trade pollution/emissions permits

Answer 7

A system employed to reduce pollution by limiting output through the issuing of “pollution permits”
- they work through firms trading them to reach an efficient outcome, firms with a higher cost of abatement will buy more permits, while those with a lower cost will sell them and reduce their pollution by a greater degree

Question 8

State provision of public goods

Answer 8

When the government is the main provider of a good or service
- often the case for public goods and merit goods

Question 9

Provision of information

Answer 9

When there is asymmetric information the government provides information to allow people to make informed decisions
- they may also force companies to provide information

Question 10

Regulation

Answer 10

Governments are able to impose laws and caps to ensure levels are set where MSB=MSC or ensure companies provide full information on products

Question 11

Government failure

Answer 11

When a government intervention results in a net welfare loss to society
- an inefficient allocation of resources which is worse than if they hadn’t intervened
- if the problems with an intervention outweigh the benefits

Question 12

Causes of government failure

Answer 12

1) Distortion of price signals
2) Unintended consequences
3) Excessive administrative costs
4) Information gaps

Question 13

Distortion of price signals

Answer 13

• max/min prices lead to excess demand/supply and make it difficult to allocate resources
• distorts price mechanism so resources may be allocated inefficiently

Question 14

Unintended consequences

Answer 14

• consumers/producers reacting to new policies differently than predicted, so policy proves ineffective
• e.g. treating patients on the NHS has lead to a decrease in quality (not government intention)

Question 15

Excessive administrative costs

Answer 15

• money allocated by gov being used on basic administration costs rather than social costs
• e.g. NHS using it for organisational administration costs rather than medical care

Question 16

Information gaps

Answer 16

Lack of/unequal knowledge of firm