LS18 - Limits to Government Intervention

Question 1

Market failure definition

Answer 1

• when the free market fails to allocate resources efficiently e.g. externalities exist

Question 2

Government failure definition

Answer 2

• when the government intervenes to correct a market failure but it instead leads to a net welfare loss e.g. black markets, unintended consequences, regressive impacts, job losses

Question 3

Regulatory capture

Answer 3

An economic theory that says regulatory agencies may come to be dominated by the industries or interests they are charged with regulating.

Question 4

Causes of regulatory capture

Answer 4

• bribery
• familiarity
• revolving door

Question 5

Bribery

Answer 5

• government officials are motivated by financial rewards
• e.g. a housing company seeking approval for a property development may be tempted to bribe the regulator in charge of granting access

Question 6

Familiarity

Answer 6

• governments often work closely with members of firms they regulate
• overtime, they may become friendly towards each other leading to bias
• UK regulators of the audit industry have been accused of this

Question 7

Revolving door

Answer 7

• regulators often go on to work for companies they previously regulated and are often paid large salaries e.g. George Osborn paid nearly 800k by Blackrock
• jobs may be rewarded due to lenient treatment during regulation

Question 8

Impacts of regulatory capture

Answer 8

• quality falls
• price may rise
• externalities
• asymmetric information due to e.g. false audit

Question 9

How is quality impacted by regulatory capture?

Answer 9

If regulators do not enforce minimum quality standards, the quality is likely to fall e.g. increased delays in the rail industry

Question 10

How is price impacted by regulatory capture?

Answer 10

• price is likely to be higher - for natural monopolies, this means regulators may be generous when setting permitted price rises e.g. RPI + 3% instead of RPI + 2%
• may have a regressive effect

Question 11

How does regulatory capture lead to external costs?

Answer 11

• external costs are likely to be ignored if regulators have been captured e.g. hygiene standards for a restaurant
• this could result in food poisoning thus causing people to miss work and increasing costs for public health care

Question 12

Example of regulatory capture

Answer 12

• alleged capture of HMRC by Vodafone, who negotiated a tax reduction from £7bn to £1bn in 2009-10

Question 13

What is the effect of a tax on goods which are causing a market failure?

Answer 13

• the effect of a tax is to internalise the external cost associated with a good/service e.g. tobacco