Market Failure - Externalities

Question 1

Advantages of Indirect TAX?

Answer 1

• Creates Gov. revenue - can be spent on dire areas, e.g. rehabilitation centers, subsidizing alternative merit goods).
• Internalises external costs - Solves mkt failure.

Question 2

Disadvantages of Indirect TAX?

Answer 2

• It may help create illegal markets (GOV. failure)
• Producers may be forced to lay off workers due to the fall in demand ~~> output.
• Regressive

Question 3

Advantages of Subsidies?

Answer 3

• Can be targeted to help specific domestic industries.
• Solves mkt failure.

Question 4

Disadvantages of Subsidies?

Answer 4

• Future Tax rises to offset cost (Damages future generations)

-Creates dependency

• Depletion of natural resources

Question 5

Evaluation of Indirect TAX?

Answer 5

• effectiveness of the tax in reducing the use of demerit goods depends on the PED of demand.
• Addiction
• Setting Tax at the right level? (Ludicrous assumption).

Question 6

Evaluation of Subsidies?

Answer 6

• Will producers just keep the money injection?
• Setting subsidy at the right level? (Have enough information?)
• PED ( lack of information ~~> price changes won’t change demand).