Government intervention and government failure

Question 1

What are the ways to correct negative externality caused market failure (6)

Answer 1

• Indirect tax
• Caps on production
• Regulation
• Subsidise substitutes
• Min prices
• Pollution permits
• Government provision
• Information provision

Question 2

How does an indirect tax solve market failure

Answer 2

Increases cost of production so supply falls to the socially optimum level of production

Question 3

What are the advantages of using a tax to solve market failure

Answer 3

Tax increases cost of production internalising the externality as the incidence of the tax is turned private

Revenue can be used to pay for external costs (healthcare)
Subsidise substitutes
Advertises to provide information about negative effects

Question 4

What are the limitations of a tax being used to solve market failure

Answer 4

• Inelastic goods will not have its demand affected
• External cost is difficult to measure so tax size is inaccurate
• unintended consequences

Question 5

What are the problems with the tax being too big or too small

Answer 5

Too small means there’s still external costs

Too big leads to fall in firm activity and black market may take its place

Question 6

What are the ways to correct positive externality market failure (5)

Answer 6

• Subsidies
• Advertising
• Government provision
• Regulation (make it compulsory)
• Maximum price

Question 7

How does a subsidy correct positive externality market failure

Answer 7

Lowers cost of production so supply (MSC = MPC + SUB)
So quantity is higher

Question 8

What are the limitations of subsidies

Answer 8

• The size of the subsidy is difficult to measure (too big = underconsum, too small = waste of resources)
• Opportunity cost
• Firms may become lazy (more profit so less incentive to be more efficienct)

Question 9

What effect does a minimum price solve market failure

Answer 9

Negative externality market failure

Question 10

How does a minimum price solve negative externality market failure

Answer 10

Min price higher than equilibrium causes output to be at socially optimal equilibrium so negative externality is internalised (overall consumption is decreased)

Question 11

Evaluate the use of minimum prices

Answer 11

• Dependant on PED
• Increases the price of the product
• Has to be set above equilibrium
• Firms’ profits rise (reinvest to make demand rise) (they will say less though)

Question 12

How does a maximum price solve market failure

Answer 12

Increases consumption getting rid of underconsumption

Question 13

Why might a maximum price not actually work

Answer 13

There will be a shortage so consumption may actually fall
Consumers may pay with time (NHS ER)

Lower prices could lead to a change in quality

Question 14

What are pollution permits?

Answer 14

Firms buy certain levels of pollution and pay a fine if they pollute more than they’ve paid for

Question 15

Why do pollution permits solve pollution in the short run and long run

Answer 15

Increasing permit prices reduce pollution and increase investment into green tech

Question 16

What are the pros and cons of pollution permits

Answer 16

Pollution has a cost
- Incentive to reduce pollution
- Investment into clean energy

Too low may not affect firms
Too high may force firms to close
Global problems require global solutions

Question 17

What is government provision and how may it solve market failure

Answer 17

Government provides the goods so there is no underconsumption as it’s free

Question 18

What are the limitations of government provision

Answer 18

• Quality dependent on government budget
• Sometimes packed
• Opportunity cost
• No profit incentive for government

Question 19

What is government regulation and how can it correct market failure give examples

Answer 19

Passing laws
- Compulsory consumption
- Age limits
- Banning
- Advertising laws

Question 20

What are the problems with government regulation

Answer 20

• Imperfect information may lead to skewed results
• Black markets may rise
• Enforcing legislation is a cost so there is opportunity cost

Question 21

What is provision of information and how can it solve market failure

Answer 21

Increases consumer knowledge about products shifting demand

Question 22

What are the limitations of Information provision

Answer 22

• Addictive goods may be unaffected
• Reduced demand may lead to loss of jobs
• Quality of adverts
• Cost of collecting information

Question 23

What is government failure

Answer 23

When government intervention to correct market failure leads to a bigger social welfare loss, or when costs of government intervention exceed the benefits

Question 24

What are the 4 types of government failure

Answer 24

• Distortion of price signals
• Unintended consequences
• Excessive administrative costs
• Information gaps

Question 25

Explain distortion of price signals and give an example

Answer 25

When the government intervenes and changes the price of a good or service, e.g., a maximum price lowering supply and hurting employment

Question 26

Explain Unintended consequences and give an example

Answer 26

When an action has unanticipated outcomes, e.g., increasing pollution permits leads companies to move production offshore

Question 27

Explain Excessive administrative costs and give an example

Answer 27

When the admin to implement an intervention makes the cost exceed the benefits, e.g., measuring sizes of taxes or subsidies

Question 28

Explain information gaps and give an example

Answer 28

When policies and interventions are not based on the right information and therefore have adverse effects

Question 29

What is regulatory failure and give an example

Answer 29

When the regulation fails to achieve its intended purpose, e.g., the black market