Government Intervention in markets (micro)

Question 1

market failure

Answer 1

Market failure happens when the price mechanism fails to allocate scarce resources efficiently or when the operation of market forces lead to a net social welfare loss.

Question 2

complete market failure

Answer 2

when the market does not supply products at all – there is a missing market
Example: Pure public goods
There is a missing market in the provision of public goods

Question 3

Partial market failure

Answer 3

when the market functions but it supplies either the wrong quantity of a product or at the wrong price
Example: Negative externalities from production

Question 4

Negative externalities

Answer 4

Negative externalities occur when production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid. This causes social costs to exceed private costs.

Question 5

Positive externalities

Answer 5

Positive externalities exist when third parties benefit from the spill-over effects of production/consumption e.g. the social returns from investment in education & training or the positive benefits from health care and medical research.

Question 6

Merit goods

Answer 6

A product that society values and judges that everyone should have regardless of whether an individual wants them. In this sense, the government (or state) is acting paternally in directly providing free at point of consumption or subsidising merit goods and services.

Question 7

Demerit goods

Answer 7

The consumption of de-merit goods can lead to negative externalities which causes a fall in social welfare. Consumers may be unaware of the negative externalities that these goods create - they have imperfect information.

Question 8

Public goods

Answer 8

Public goods are commodities or services that benefit all members of society, and which are often provided for free through public taxation.
Public goods are the opposite of private goods, which are inherently scarce and are paid for separately by individuals.
Societies will disagree about which goods should be considered public goods; these differences are often reflected in nations’ government spending priorities.
- Non-rival
- Non-excludable
- Non-Rejectable

Question 9

Private goods

Answer 9

goods and services supplied and sold through markets by private sector businesses.
- Excludable
- Rivalrous
- Rejectable

Question 10

Quasi goods

Answer 10

A quasi-public good is a near-public good. It has some of the characteristics of a public good especially when it becomes rival in consumption at times of peak demand.

Question 11

Free-rider problem

Answer 11

A free rider is a person who benefits from a good or service without paying for it. The free rider problem refers to the difficulty of providing a public good or service when some individuals can consume it without contributing to its production or financing. This can result in under-provision or non-provision of the good or service, since those who would benefit from it have little incentive to pay for it.

Question 12

Missing market

Answer 12

Missing markets are associated with the difficulties that the free market has in providing pure public goods. Public goods are non-excludable meaning that the benefits derived from them cannot be confined solely to those who have paid for it. Non-payers can enjoy the benefits of consumption at no financial cost to themselves (aka free riders)

Question 13

Internal Costs/Benefits

Answer 13

The cost/benefits incurred/gained by the economic agent for producing or consuming a product.
Private costs = Internal costs
Private benefits = Internal benefits

Question 14

External Costs/Benefits

Answer 14

The costs/benefits incurred/gained by other economic agents in society for producing/consuming a product
Social costs = Internal cost + External cost
Social benefits = Internal benefits + External benefits

Question 15

The margin

Answer 15

A concept which refers to the next unit or item. It considers what would happen if the variable increased or decreased by one unit.

Question 16

How do you model an externality?

Answer 16

1) Draw private cost (MPC) and benefit curves (MPB)
2) Production or consumption externality? Production = cost curve, consumption = benefit curve. MPC=MSC
3) Positive or negative externality? Positive = outwards shift, negative = Inwards shift

Question 17

Tragedy of the commons

Answer 17

When no one owns a resource, it may get over-used, for example fish stocks and deforestation - people use and benefit from a common pool resource such as grazing land without regard to the effects on others.

Question 18

Indirect tax

Answer 18

An indirect tax is imposed on producers (suppliers) by the government. Examples include excise duties on cigarettes, alcohol and fuel and also value added tax.

Question 19

Government failure

Answer 19

Policies that cause a deeper market failure. Government failure may range from the trivial, when intervention is merely ineffective, to cases where intervention produces new and more serious problems that did not exist before.

Question 20

Subsidy

Answer 20

Payments by the government to suppliers that reduce their costs. The effect of a subsidy is to increase supply and therefore reduce the market equilibrium price.

Question 21

Minimum price

Answer 21

Minimum prices are legally-imposed price floors and are most associated with minimum hourly wage rates in the labour market or guaranteed price support schemes for farmers and other producers. They might also be a legal minimum retail price such as the minimum alcohol price introduced into Scotland.

Question 22

Maximum price

Answer 22

A legally-imposed maximum price in a market that suppliers cannot exceed - in an attempt to prevent the market price from rising above a certain level. To be effective a maximum price has to be set below the free market price.

Question 23

Reasons for government price controls

Answer 23

• make some goods more expensive
• make some goods cheaper
• stabilise prices
• minimums price creates a surplus
• maximum prices, when gov wants to prevent prices going above a certain level but if price below equilibrium will lead to a shortage

Question 24

state provision

Answer 24

State provision: also known as direct provision – when a nationalised industry is the main provider of a good or service. Often the case for public goods and merit goods.

Question 25

regulation

Answer 25

Regulation is defined as a set of rules, normally imposed by government, that seeks to modify or determine the behaviour of firms or organisations

Question 26

excess supply

Answer 26

Excess supply, also known as surplus, refers to a situation in which the quantity of a good or service that is being offered for sale exceeds the quantity that is being demanded by consumers at the current price. This can lead to a decrease in the price of the good or service, as producers may need to lower the price in order to sell the excess supply.

Question 27

excess demand

Answer 27

This is a situation that occurs when demand exceeds supply at a given price. Also known as a shortage

Question 28

Pollution permits

Answer 28

Pollution permits involve giving firms a legal right to pollute a certain amount e.g. 100 units of Carbon Dioxide per year.
If the firm produces less pollution it can sell its pollution permits to other firms.
However, if it produces more pollution it has to buy permits from other firms or the government.
This creates a market for pollution permits with the price set by demand and supply.
The aim of pollution permits is to provide market incentives for firms to reduce pollution and reduce the external costs associated with it. For example, it is argued carbon dioxide emissions contribute towards global warming.
Pollution permits can also be a way for the government to raise revenue, by selling firms these permits to allow pollution.

Question 29

Natural monopoly

Answer 29

Markets where is makes sense to have a single provider

Question 30

Political moves

Answer 30

Privatisation + nationalisation in the UK has long been seen as a political issue

Question 31

financial regulation

Answer 31

• Bonuses
• Ring-fencing
• Capital limits

Question 32

Tax revenue

Answer 32

Collected by the supplier. Means that tax levied affects the supply curve. After a tax is imposed, a supplier will only supply the same quantity of a good if the price covers the tax. This is shown by a vertical shift in the supply curve.

Question 33

specific tax

Answer 33

Taxes where the tax base is on the volume purchased - amount of tax is the same for each unit.
Introduction of tax shifts the supply curve vertically upwards by the amount of the tax. This creates a new equilibrium in the market. The amount of tax can be shown by a vertical line from the new equilibrium point down to the original supply curve.

Question 34

incidence of taxation - consumers

Answer 34

Shown by the rise in price from p1 to p2. The total amount of tax that consumers pay is shown by the grey area (Booklet page 4)

Question 35

incidence of taxation - producers

Answer 35

That which is not passed onto consumers (p1 to p3). The total amount of tax payed by producers is shown by the grey area.

Question 36

Ad valorem taxes

Answer 36

Analysis is exactly the same as for specific taxes, except the supply curve is skewed when it is shifted upwards, this is because the higher the price, the higher the amount of tax that has to be payed (Ad valorem taxes are calculated as a % of price)

Question 37

Taxes and subsidies rules

Answer 37

Affect the suppliers cost of production, so shift the S curve. Amount of tax revenue (or subsidy expenditure):
- start from the new equilibrium
- draw a vertical line to the original supply curve - this is the tax/subsidy per unit.
- multiply by the new equilibrium quantity for full amount gained/spent by government.