Govt Intervention in Market Failure Flashcards
Tax for Negative Externalities
An indirect tax increases COP, reducing profitability and hence producers reduce their production to MPC’. An indirect tax = MEC at social optimal quantity Qs increases the MPC of producers to MPC’, forcing producers to internalise external costs to third parties.
The private optimal quantity Qp’ now coincides with social optimal qty Qs.
The fall in production/consumption from Qp to Qp’ eliminates deadweight loss of shaded area abc.
Allocative efficiency is achieved and social welfare is maximised.
Eval: Price inelastic DD; Imperfect Info vis a vis monetising MEC
Rules and Regulations - Negative Externalities
Laws can be passed to make installation of cleaner technologies mandatory, reducing external costs to third parties.
With a fall in MEC, the MSC shifts downwards from MSC1 to MSC2, where the social optimal quantity Qs will increase and be closer to the private optimal quantity Qp.
This reduces extent of overconsumption and hence deadweight loss generated.
Pros: outcomes are more certain and can be achieved faster vs taxes
Cons: administrative and monitoring costs —> unsustainable in LR;
if penalties and rules are too harsh, firms may leave industry —> economic downturn
Quota - Negative Externalities
The government can impose a production quota at socially optimal output level Qs, achieving allocatively efficient ouput and eliminating deadweight loss (shaded area abc).
Pros:
—> Easy to implement by directly imposing a limit, compared to market-based policies like taxes where technical difficulties such as PED has to be estimated
—> Greater certainty in achieving target output level to maximise social welfare
Cons:
—> Costs of monitoring and regulation
—> Does not provide market-based incentives (vs. tradable permits) -> strict quotas may drive large firms out -> economic downturn
Ban (Quota at Zero) - Negative Externalities
A ban is a legally imposed quota where the output is set at zero, which is socially optimal when the MEC is very large such that MSB intersects MSC where the social optimal quantity is close to or at zero.
A ban completely eradicates all negative externalities generated from the consumption of X.
For the imposition of a ban where there is significant MEC, welfare loss will be area A, since MSB > MSC for output between 0 and Qs. Area B is the deadweight loss from the market failure.
Since area A<b></b>
Subsidies for Positive Externalities/Merit Goods
Subsidy granted by govt decreases private costs of consumers, increasing willingness and ability of consumers to consume the good and allow the socially optimal level of the good to be consumed.
Granting a subsidy equal to the amount of MEB and information gap at the social optimal quantity Qs will lower the MPC of consuming education by that amount, forcing consumers to internalise the external benefits to third parties, shown by a downward shift of the MPC curve from MPC to MPC’.
The new private optimal quantity Qp’ now coincides with social optimal quantity Qs.
The increase in consumption from Qp to Qp’ eliminates deadweight loss (shaded area abc). Allocative efficiency is achieved and social welfare is maximised.
Patent Laws - RnD Production
Patent laws enforced by the govt gives firms greater private benefits that they can potentially receive from their innovation, shown by an upward shift of the MPB curve from MPB to MPB’
At the same time, MEB is eliminated as other firms cannot imitate the RnD efforts by the firm, hence MPB’=MSB
The new private optimal quantity Qp’ now coincides with social optimal quantity Qs.
The rise in production from Qp to Qp’ eliminates deadweight loss (abc).
Allocative efficiency is achieved and social welfare is maximised.
Direct and Joint Provision - Public Goods
Direct Provision:
Assuming perfect information, govts may provide public goods at socially optimal level Qs, maximising society’s welfare, and this production is financed via tax revenue.
Cons: lack of info on social opt qty to provide - too little/much of the good provided -> govt failure
Opp cost of funding + Provision cost
Joint Provision:
Govt and profit max private firms both provide GnS in the market/ govt and private firms involved in diff parts of production of a G/S
Cons: Lack of incentive to keep costs low due to no profit motive - costs covered by tax revenue
Govt Intervention for Factor Immobility
- SkillsFuture
Pro: root cause
Con: Long time period for effect; some use skillsfuture credit to take on courses as leisure - baking courses
- Developed Transport Infrastructure
improve interconnectivity —> improve geog mobility
Con: Costly, opp cost, may lead to budget deficit and need to raise tax revenue in future
Public Educational Campaigns - Asym Info
Govt agenices directly supply information to the public, allowing consumers to be aware of the costs and benefits —> allowing allocative efficient outcome to be achieved and DWL to be eliminated
Limitation: mindsets difficult to change; uncertain outcome
costly to disseminate all necessary info
Laws - Asymmetrical Information
Govt pass laws to ensure quality standards must be maintained by producers of GnS, and that producers divulge necessary and accurate information to consumers
Actual MPB and MPC will be accounted for —> allowing allocative efficient output to be achieved and DWL eliminated
Eval: always some form of asymm info esp. in technical sectors like law and healthcare —> supplier-induced demand
GI for Adverse Selection
1) Mandatory participation - Medishield insurance, Obamacare
Adverse selction gaps found in voluntary and opt-out schemes can thus be avoided
2) Protect consumers against defective goods
Eg. Lemon laws in SG - 2nd hand car buyers can request full repair of defective parts within a stipulated time period post purchase
GI for Moral Hazard
Make co-payment of costs compulsory (legally)
Insurance
