Economics 1.4: Government Intervention

• What is the purpose of introducing indirect taxation in markets with negative externalities?

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

  It shifts from S1 to S2
• What is the free market equilibrium position before the introduction of an indirect tax?

  P1Q1, where MPC=MPB
• What is the social optimum position after the introduction of an indirect tax?

  P2Q2, where MSB=MSC
• What is the effect of an ad valorem tax compared to a specific tax?

  Same effect, different curve shift
• Why does indirect taxation internalize the externality?

  It shifts the supply curve to reflect social costs

  
• What is one advantage of indirect taxation?

  It raises government revenue
• Why is it difficult to target indirect taxes effectively?

  Due to imperfect information about externality size
• What is one disadvantage of indirect taxation?

  It can lead to black markets
• Why might indirect taxes be politically unpopular?

  They are regressive and affect the poor more
• What is an example of an indirect tax used for externalities in the UK?

  Fuel duties
• What is the purpose of subsidies in markets with positive externalities?

  To shift the supply curve to the right
• What is the free market equilibrium position before the introduction of a subsidy?

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

  Q2P3, where MSC=MSB
• What is one advantage of subsidies?

  They maximize social welfare
• Why might subsidies cause producers to become inefficient?

  They reduce the incentive to cut costs
• What is one disadvantage of subsidies?

  They have a high opportunity cost
• Why are subsidies difficult to remove once introduced?

  Producers become dependent on them
• What is an example of a subsidized good?

  Solar panels
• What is the effect of a maximum price set below the equilibrium price?

  Excess demand occurs
• What is the purpose of a maximum price?

  To make goods affordable
• Why might maximum prices lead to black markets?

  Goods are allocated illegally at higher prices
• What is an example of a maximum price implementation?

  Rent controls in Manhattan
• What is the effect of a minimum price set above the equilibrium price?

  Excess supply occurs
• What is the purpose of a minimum price?

  To ensure producers get a fair price
• Why might minimum prices lead to black markets?

  Goods are sold illegally at lower prices
• What is an example of a minimum price implementation?

  Minimum price on alcohol in Scotland
• What is the purpose of tradable pollution permits?

  To limit the maximum amount of pollution

  
• What happens if a company exceeds its pollution limit?

  It faces legal action
• Why do companies have an incentive to cut emissions with tradable permits?

  To reduce costs and increase profits

  
• What is one advantage of tradable pollution permits?

  They guarantee pollution will fall

  
• Why are tradable pollution permits expensive to monitor?

  They require strict enforcement and fines
• What is an example of a successful tradable pollution permit scheme?

  US Sulphur trading scheme
• Why does the government provide public goods?

  To correct market failure
• What are the characteristics of public goods?

  Non-excludable and non-rivalry
• Why are public goods under-provided by the free market?

  Due to the free rider problem
• What is one advantage of state provision of public goods?

  It corrects market failure
• How does state provision of public goods promote equality?

  By ensuring access to basic goods
• What are the steps involved in the introduction of indirect taxation?

  1. Identify the negative externality
  2. Introduce the tax to shift the supply curve
  3. Reach the social optimum position (MSB=MSC)
  4. Internalize the externality and maximize social welfare
• What are the key features of tradable pollution permits?

  • Government caps the number of permits
  • Companies must buy permits to pollute
  • Unused permits can be sold
  • Companies exceeding limits face legal action
  • Encourages investment in green technology