Week 11 Gov Intervention (Topic 9 & 10)

Question 1

What causes market failures?

Answer 1

1. Externalities
2. Public goods
3. Market power
4. Immobility of factors
5. Protection of public interest

Question 2

Describe external cost of production

Answer 2

External costs of production
MSC > MPC (where MSB = MPB)

MSC = MPC + MEC

Upward sloping MEC

Overconsumption of a good leading to MCS being larger than MPC

Question 3

Describe external benefit of production

Answer 3

external benefit of production
MSC < MPC (MSB=MPB)

Downward sloping MEB

Under consumption

increase until MSC = MPC - MEB

Question 4

Describe external cost of consumption

Answer 4

external cost of consumption
MSB < MB (MSC = MPC)

Upwards Sloping MEC

Over consumption

Decrease consumption until
=> MSC = MSB - MEB

Question 5

Describe external benefits of consumption

Answer 5

external benefits of consumption
MSB > MB (MSC =MPC)

Downward slopping MEC

Under consumption at a price too low

Increase price + quantity until
=> MSB = MPB + MEC

Question 6

What are public goods?
Describe their characteristics

Answer 6

Goods produced or subsidised by the government
= > free market will not produce them

Non-rivalry
- One person’s consumption does not prevent another person’s consumption

Non-excludable
- Everyone can use the good

Question 7

Why and how does the government intervene in monopoly markets?

Answer 7

Monopoly profit maximisation produces a dead weight loss (under prodcution)

Solution
=> Subsidise firm to increase production until MC = AR = MSB = MSC

Question 8

What are the 8 types of government intervention?

Answer 8

1. Taxes/subsidies
2. Minimum wages
3. Tariffs
4. Blocking mergers
5. Deregulation
6. Fiscal policy
7. Policy to increase productivity
   8 Environmental policy

Question 9

What are the arguments against gov intervention

Answer 9

1. Causes shortages or Surplus
   Price Floor = surplus
   price ceiling = Shortage
2. Insufficient information
   => full costs + benefits unknown
3. Bureaucracy and Costs
   - Increased administration costs
4. Lack of market incentive
   - allows inefficient firms to survive
5. Shifts of policy
   - Makes future planning hard
6. Lack of freedom
   - Reduces free choice of economy

Question 10

How can government intervention be reduced?

Answer 10

1. Privatisation
2. Deregulation
3. Contracting out

Question 11

What are the pro privatisation arguments?

Answer 11

1. Market forces
   - Increased competition
   - Efficient spending
2. Less government Intervention
   - Less political influence
3. Financing tax cuts
   - reduced debt + increases tax revenue

Question 12

What are the arguments against privatisation?

Answer 12

1. Natural monopolies
2. Public interest
   - MSB & MSC generally ignored

Question 13

What is contracting out and what does it do?

Answer 13

Contracting out
- government offering contracts for jobs

increases ex-ante competition

Question 14

What are incentive payments?

Answer 14

Two part payment plans to ensure contact achieves desired outcome

Question 15

What are the issues of contacting ?

Answer 15

Ensuring the contacts are completed properly

Question 16

What are the advantages and disadvantages on tax/subsidies as a government intervention?

Answer 16

Pros
- Market sets equilibrium
- Can increase welfare
- Holds firms accountable

Cons
- Governments need perfect information
- Taxes impact firms differently

Question 17

How do taxes affect markets with elastic demand?

Answer 17

• Large drop in quantity
• small drop in price
• Producers take majority of tax burden

Question 18

How do taxes affect markets with inelastic demand?

Answer 18

• small drop in quantity
• large increase in price
• Consumers take majority of tax burden

Question 19

How do taxes on elastic goods affect producers?

Answer 19

1. Earn less per unit
2. Drives innovation as firms compete for the reduced quantity

Question 20

What are the two types of controls for externalities?

Answer 20

1. command and control
   - Impose quantitive limits on externalities
2. Tax/subsidise
   - Tax negatives and subsidise positives

Question 21

What are the advantages of a tariff?

Answer 21

• gov revenue
• Protects infant industries
• Encourages new market entrants
• Allows self sufficiency
• Protects domestic goods
• Preserves traditional industries

Question 22

What are the disadvantages of tariffs?

Answer 22

• Creates DWL
• Allows inefficient markets to survive
• Retaliation from other countries

Question 23

What is a natural monopoly?

Where is P set?

Answer 23

Market where one firm can produces at a lower average total cost and supply the whole market

P = normal profit maximisation MC=MR

Question 24

What is a nationalised monopoly?

Where is P set?

What are the disadvantages?

Answer 24

A nationalised monopoly is a government-owned monopoly

p = MC

Cons
- run at loss
- x - efficiency (subsidies by another tax)

Question 25

What is a state regulated monopoly? Where is P set? Pros and Cons?

Answer 25

Monopoly where price is controlled by govenment P is set at D = LRAC Pros - No subsidy needed as earns normal profit Cons - Not allocatively efficient - Less consumer surplus - No incentive to innovate to reduce LRAC

Question 26

What is price Cap regulation? Pros and cons?

Answer 26

Government sets maximum price of the monopoly pros - incentivises innotvate to reduce LRAC by allowing economic profit Cons - Hard to pick correct P => too low means forced losses => too high means excessive profits