1.4 gov intervention

• What is the purpose of indirect taxation when a good has a negative externality?

  To prevent market failure
• What happens to the supply curve when indirect taxation is introduced?

  The supply curve shifts from S1 to S2
• Where does the free market produce in relation to the marginal private cost (MPC) and marginal private benefit (MPB)?

  At P1Q1, where MPC=MPB
• What is the social optimum position in terms of marginal social benefit (MSB) and marginal social cost (MSC)?

  At P2Q2, where MSB=MSC
• What does the introduction of the tax achieve in terms of equilibrium position?

  The equilibrium position becomes S2=MPB=MSB at P2Q2
• How does the tax affect social welfare?

  It internalises the externality and maximises social welfare
• What type of tax can also be introduced besides a specific tax?

  An ad valorem tax
• What are the advantages of indirect taxation?

  • Internalises the externality
  • Raises government revenue for other solutions
  • May help goods become more elastic in the long run
• What are the disadvantages of indirect taxation?

  • Difficult to know the size of the externality
  • Conflict between raising revenue and solving the externality
  • Potential for black market creation
  • Ineffective if demand is inelastic
  • Politically unpopular
  • Regressive nature
• What are some examples of indirect taxes used for externalities in the UK?

  Landfill taxes, fuel duties, alcohol duties, tobacco duties, air passenger duties, sugar taxes
• What is the purpose of subsidies introduced by the government?

  To solve positive externalities and fix information gaps
• What effect do subsidies have on the supply curve?

  They shift the supply curve to the right
• Where does the free market produce in relation to MPC and MPB before the introduction of a subsidy?

  At Q1P1, where MPC=MPB
• What is the social optimum position after the introduction of a subsidy?

  At P2Q2, where MSC=MSB
• What does the introduction of a subsidy achieve in terms of social welfare?

  It maximises social welfare by producing at the output that best allocates resources
• What are the advantages of subsidies?

  • Society reaches the social optimum output
  • Encourages small businesses
  • Brings about equality
  • Encourages exports
• What are the disadvantages of subsidies?

  • High opportunity cost for the government
  • Difficult to target due to unknown externality size
  • Can cause inefficiency in producers
  • Difficult to remove once introduced
• What are some examples of subsidies?

  Biofuels, solar panels, apprenticeship schemes, wind farms, rail industries
• What is the condition for a maximum price to have an effect?

  It must be set below the current price equilibrium
• What is the condition for a minimum price to have an effect?

  It must be set above the current price equilibrium
• What is a maximum price?

  A legally imposed price that suppliers cannot charge above
• On what types of goods are maximum prices typically set?

  On goods with positive externalities
• What is the effect of imposing a maximum price on the equilibrium position?

  It creates excess demand

  
• What is a minimum price?

  A legally imposed price that cannot go below a certain level
• On what types of goods are minimum prices typically set?

  On goods with negative externalities
• What is the effect of imposing a minimum price on the equilibrium position?

  It creates excess supply

  
• What are the advantages of maximum and minimum prices?

  • Set where MSB=MSC to consider externalities
  • Ensure affordability for consumers with maximum prices
  • Ensure fair prices for producers with minimum prices
  • Can reduce poverty and increase equity
• What are the disadvantages of maximum and minimum prices?

  • Distortion of price signals causing excess supply/demand
  • Difficulty in knowing where to set prices
  • Potential for black markets
  • Maximum prices may lead to illegal bribes or discriminatory policies
• Where have maximum prices been implemented?

  In Manhattan for rent controls
• What has happened in Venezuela due to price caps on key goods?

  Creation of a black market and goods no longer sold in supermarkets
• What is the aim of the minimum price imposed on alcohol in Scotland?

  To cut down on binge drinking
• What negative effect can the minimum price on alcohol have?

  It may negatively affect those who are addicted
• What issue has arisen from minimum prices on Limousines in Nashville?

  Stifled competition as price-competitive firms are forced out
• What does a pollution permit allow the owner to do?

  Pollute up to a specific amount
• How does the government control pollution permits?

  By limiting the maximum amount of pollution through the number of permits
• What incentive do companies have to use greener technology regarding pollution permits?

  To cut costs and increase profits

  
• What happens to unused pollution permits?

  They can be sold to other companies
• What happens if companies exceed their pollution limit?

  They will face legal action
• What happens to the price of pollution permits when demand increases?

  The price of permits increases
• What are the advantages of tradable pollution permits?

  • Guaranteed reduction in pollution to government targets
  • Government can raise revenue by selling permits
  • Encourages investment in green technology
  • Firms can decide whether to cut pollution or buy more permits