Government intervention and government failure 1.4

• rule of law, property rights

  correction of market failure

  equitable distribution of income

  improve performance of the economy

  Reasons for government intervention
• correcting market failure due to negative externalities


  INDIRECT TAX:

  increases cost of production so less supply, pushes up price so consumers demand less- if equal to social cost then quantity will move to socially optimal levels
• regressive

  hard to get right

  incidence of tax depends on elasticity

  reduction in trade depends on elasticity

  costs of administration

  inflation

  main objective of tax


  Evaluation of tax to correct market failure
• Correcting market failure due to positive externalities


  SUBSIDIES:

  costs of production are funded so producers increase supply, this pushes down price so consumers demand more- if it is equal to social benefits then quantity will move to socially optimal levels
• incidence depends on elasticities

  hard to get right

  increase in trade depends on elasticities

  resources reallocated from other causes (XED)

  opportunity cost


  Evaluation of subsidies to correct market failure
• price control


  legally imposed maximum or minimum prices from the government
• price ceiling


  legally imposed maximum price, imposed when prices rise faster than wages and supports the population so they can afford necessities, only makes sense below equilibrium price

  
• shortage

  other means of rationing

  hoarding

  black market

  deteriorating quality

  Problems with the price ceiling
• low prices

  other rationing

  low quality

  shortage

  black market


  analysis of price ceilings: consumers
• low prices

  reduced surplus

  less jobs

  reduced fund for innovation and growth

  analysis of price ceilings: producers
• deal with shortages:

  subsidies

  black market

  enforcement

  analysis of price ceilings: government
• depends on difference between cap and market price

  depends on PES and PED

  inefficient use of resources by consumers (buying more than needed)


  evaluation of price ceilings
• price ceilings and elasticities


  the more inelastic the less the impact of price ceilings
• price floors


  legally imposed minimum price

  only makes sense above equilibrium price

  imposed if price of labour falls (ensures people have enough money)

  protects industries and jobs

  reduces consumption of demerit goods
• high price

  less choice

  less surplus

  depends on elasticities

  have less money to spend elsewhere

  analysis of price floors: consumers
• increased surplus (if bought by gov)

  excess supply

  less profits

  increased revenues

  less incentive to innovate


  analysis of price floors: producers
• have to deal with excess supply:

  intervention buying

  opportunity cost of this


  analysis of price floors: government
• price increase fully passed to consumer

  excess supply on black market

  cross border shopping (bad for local business)

  reformulation of bad goods

  harmful substitutes

  no tax revenue

  expensive to enforce

  should be set at a level to reduce to socially optimal quantity


  evaluation of price floors
• tradable pollution permits: why not tax


  no guarantee to reduce pollution

  unlikely to have significant effect as energy has inelastic demand due to it being an essential

  rich firms can cover cost and carry on polluting
• tradable pollution permits


  limits place on carbon emissions through permits which can be freely traded

  fines imposed if limits exceeded

  those who underproduce can sell excess permits

  internalises external costs

  biggest polluters pay the most to pollute, most compensation for negative externalities
• advantages of tradable pollution permits


  incentives to reduce pollution (can profit off it)

  market based (pollution reduced at the lowest cost)

  firms decide their most efficient solution
• disadvantages of tradable pollution permits


  hard to decide appropriate levels

  administration costs

  difficult to set the right amount of fines

  restriction to competition

  uneven geographical pollution

  requires international cooperation

  no tax revenues
• decreasing tradable pollution permits


  the government reduces the amount of permits supplied each year, this causes the price of permits to increase each year until eventually it is cheaper to reduce pollution than to buy more permits
• command and control intervention


  legally enforced rules on producers and consumers to regulate their behaviour

  reduce external costs or increase external benefits

  best suited to inelastic PED where taxes have little effect
• restricted choice

  maximising MPB is limited


  analysis of command and control: consumers
• cost of regulation

  barriers to entry-reduced competition


  analysis of command and control: producers
• cost of enforcement

  regulatory capture


  analysis of command and control: government
• provision of information


  government led initiative to inform producers and consumers of the true costs and benefits of their activity
• reduce or increase demand

  improve health

  better choices

  analysis of provision of information: consumers
• respond to changes in preference

  analysis of provision of information: producers
• minimise cost and maximise benefit

  cost of campaigns


  analysis of provision of information: government
• may be expensive

  cost benefit analysis of who to target


  evaluation of provision of information
• government provision of public goods


  normative issue

  provided on grounds of: need (eliminate free riders), fairness, efficiency (economies of scale- larger scale= smaller cost per unit), social welfare
• evaluation of government provision of public goods


  lack of competition

  no incentive to innovate

  private sector crowded out- loss of innovation and employment