4) Government Intervention

• List the ways that a government can limit market failure?

  • Indirect Taxes
  • Subsidies
  • Maximum Prices
  • Minimum Prices (and Wages)
  • Tradeable Pollution Permits
  • State Provision (Public Goods)
  • Provision of Information
  • Regulation
• Describe and explain on a graph, without a graph, the effects of an indirect tax on market failure.

  • Draw a graph of welfare loss
  • Private Marginal Cost will shift to the left.
  • The amount produced will be closer to the Socially Optimum Level
• Describe and explain on a graph, without a graph, the effects of a subsidy on market failure.

  • Draw a graph of welfare gain
  • Shift Social Marginal Cost to the left
  • The amount produced is now closer to the socially optimum amount
• What is a maximum price and what does it achieve?

  A price ceiling prevents firms from extorting consumers for products that they require.
• Give two types of market in which a maximum price will prevent market failure in?

  Monopoly

  Oligopoly
• Give three examples of types of market in which a minimum price would be used to prevent market failure.

  • Crops
  • Demerit good
  • Labour market
• What is a Tradeable Pollution Permit?

  A right to sell and buy potential pollution over the course of a year
• Why might the state provide some public goods?

  Without state provision, due to the free rider problem, no firm would be willing to provide the product as it is unprofitable
• How do governments afford to provide public goods?

  Taxation
• In order to reduce information gaps and to prevent asymmetric information, the government may attempt to provide information via schools, for example
• Why might the government choose to regulate some markets?

  The products may cause negative externalities and, without strict law enforcement, the free market may allocate too many resources towards the product, harming society
• What is government failure?

  When government intervention results in welfare loss.
• What may cause government failure?

  • Distortion of price signals
  • Unintended consequences and externalities
  • Excessive administrative costs
  • Information gaps
• Why are information gaps a reason for government failure?

  Before intervening in a market, the government is unlikely to have the complete information. As a result, their intervention may negatively affect a party and move output away from socially optimum.
• Why must the government effectively calculate all costs before intervening in a market?

  The administrative and raw cost of the intervention may exceed the amount saved by achieving socially optimum production.