Government Intervention Flashcards
(21 cards)
What is an Indirect Tax?
Taxes imposed on producers (suppliers) by the government;
producers may be able and choose to pass on some or all an indirect tax to their customers by raising prices.
Indirect taxes are a form of government intervention in markets often with the aim of addressing market failure.
Examples include duties on cigarettes, alcohol and fuel, the sugar levy, VAT
and carbon taxes
What is Tax Incidence?
How the final burden of a tax is shared between the producers and the consumers.
Advantages of an Indirect Tax?
• Corrects market failures e.g.
negative externalities, information
failures that lead to over-provision
• Deters consumption of goods that
are bad for us, e.g. tobacco, sugar
• Source of revenue for government
• Helps tackle climate change
Disadvantages of an Indirect Tax?
• Regressive
• Hard to determine best size of tax
• Compliance costs
• Possible tax avoidance/evasion
• Black market activity
• Government failure/unintended
consequence
What are Producer Subsidies?
Payments to producers by the government to reduce the costs of production
E.g. subsidies for renewable energy; shifts supply right
What are Consumer Subsidies?
Payments to consumers to allow them to purchase more of a good/service
E.g. childcare vouchers;
shifts demand right
Advantages of Producer Subsidies?
• Corrects market failures e.g. positive externalities, information failures that lead to under-provision
• Encourages consumption of goods that are good for us, e.g. healthcare; fresh fruit
• Encourages firms to invest & innovate
• Helps protect producer incomes & jobs
• Supports those on lower incomes
• Can help tackle climate change
• Can help make exports more competitive
Disadvantages of Producer Subsidies?
• Cost to government (opportunity cost)
• Firms may become over-reliant on
subsidy
• Firms have less incentive to be efficient and productive
• Firms may distribute extra profit to
shareholders rather than re-invest
• May cause fraud/corruption
• Government failure/unintended
consequences
Evaluation of subsidies?
• Are the subsidies meeting their aims?
• Does the outcome depend on the size and scope of the subsidy? Or on the elasticity of demand or supply?
• Will the subsidy promote efficiency?
• What is the opportunity cost of the subsidy? Who will gain/loss from the subsidy cost?
• Does the subsidy help correct a market failure?
• Are there unintended consequences? Government failure?
These ideas/questions could be applied to indirect taxes when evaluating to
What is a Maximum Price?
The government or an industry regulator can set a maximum price to prevent the market price from rising above a certain level.
Also known as a price cap or price ceiling
Reasons for a Maximum Price?
• To make necessities more affordable, especially for those on low incomes (more equitable); reduces poverty/hardship
• To encourage consumption of goods that are good for social welfare, have positive externalities or where consumers may lack all information
• To prevent businesses profiteering at expense of consumers
Costs of a Maximum Price?
• The maximum price causes a shortage of the good.
• There is a disequilibrium at the maximum price.
• The price cannot rise to remove the excess demand – it has lost its
rationing function
• The quantity supplied will need to rationed in a different way, e.g. first
come, first served; waiting lists; preferred customer priority; ration
books; via shadow market activity
• There is potential for government failure and unintended
consequences.
Examples of a Maximum Price in markets?
• Rent controls
• Energy price cap
• Cap on bonuses and CEO pay
• Cap on mobile phone roaming
charges
• Price caps for water companies
• Cap on university tuition fees
• Bus fare price cap
• Cap on interest rates
charged by pay day lenders
• Currency pegs
• Cap on annual charges for
occupational pension plans
• Tickets prices for events
Problems with Maximum Pricing?
• Excess demand needs addressing; alternative rationing methods may
not work well
• Suppliers may leave the market if they cannot charge a price high
enough to make profit (which would increase any shortage created by
the maximum price)
• There may be better alternative policies the government could use if it believes the market price is too high
E.g. subsidies, provision of
information, redistribution from rich to poor, government provision
What is a Minimum Price?
The government can set a minimum price to prevent the market price from falling below a certain level.
Also known as a price floor.
What is a Guaranteed Minimum Price?
The government will buy up and excess supply to guaranteed the minimum price
e.g. some agricultural minimum prices.
What is a Legal Minimum Price?
The government sets the minimum by law; there is a ban on sales below the price set; the government does not buy up any surplus
E.g minimum price of alcohol, such as Scotland with a minimum 50p charge per unit of alcohol.
Reasons for a Minimum Price?
• To support the incomes and jobs of producers and encourage investment and innovation
• To discourage consumption of goods that are bad for social welfare, have negative externalities or where consumers may lack all information
• To prevent consumers abusing any monopsony power they have at
expense of suppliers
Costs of a Minimum Price?
• The minimum price causes a surplus of the good
• There is a disequilibrium at the minimum price
• The price cannot fall to remove the excess supply – it has lost its
signalling and incentivising functions
• For a legal minimum, firms cannot sell more than Qd so they will
reduce their supply (supply shifts left)
• For a guaranteed minimum the government will buy up the surplus at the minimum price (cost to government = QdABQs)
• There is potential for government failure and unintended consequences
Examples of a Minimum Price in markets?
• Minimum price for alcohol
• Agricultural support where
• National minimum/living wage
price is guaranteed to farmers
• Minimum care worker price
• Guaranteed prices for
renewable energy suppliers
Problems with Minimum Prices?
• Excess supply needs addressing
• For legal minimum price – suppliers cannot sell any excess, so they will cut supply, output and jobs
• For guaranteed minimum price – intervening to buy up the surplus can be expensive (opportunity cost); surplus will need storing, selling on,
destroying etc.
• There may be better alternative policies the government could use if it believes the market price is too low
E.g. indirect taxes, provision of
information, regulations, government ban/restriction; direct grants to
support producers
