2.11 Government Intervention

• Subsidies - Payments made to producers which effectively reduce costs and encourage them to increase output.
• Regulations e.g. bans limits- Governments sometimes seek to tackle market failures by putting into place legal restrictions on the behaviour of firms and consumers.
• Merit goods- These are underprovided in a market economy. The social benefits are greater than the private benefits.
• Direct taxes- A tax on income.
• Maximum prices- This is a price ceiling. To be effective, it has to below the market equilibrium. This is to increase demand such as rent and make goods or services more affordable.
• Market failure- This refers to a situation in which markets produce undesirable outcomes. This occurs in the form of inefficient resource allocation or a lack of equity.
• Positive externalities - The third party benefits arising from the consumption or production of goods and services.
• Methods of government intervention:

  >Indirect Taxes

  >Direct Taxes

  >Subsidies

  >Maximum Prices

  > Minimum Prices

  > Buffer stock policy intervention

  > Regulations e.g. bans, limits

  > State provision

  >Provision of more information
• State provision- Where the state pays for the good or service entirely making them largely free of charge.
• Government Intervention- This used to correct market failures arising from inefficient resource allocation or a lack of equity
• Inequalities in the distribution of income and wealth- 20% of income earners enjoy as much as 50% of national income
• Indirect Taxes- A tax imposed by the government on producers, often to reduce the number of resources allocated to that product.
• Demerit goods- These are over provided in a market economy. The social cost of consumption exceeds the private costs.
• Competition policy

  Government action to increase competition in markets.
• Government failure

  When government intervention leads to a net welfare loss in society. or Costs if intervention outweigh the benefits of intervention leading to a worsening of allocation of resources
• Information provision

  When the government intervenes to provide information to correct market failure.
• Public/ private partnerships

  When the government and the private sector work together to build and operate projects.
• Regulation

  Laws to address market failure and promote competition between firms.
• Causes of government failure

  1. Information failure - bad assumption that politicians experts making policies has perfect info especially valuing negative externalities
  2. Admin / enforcement costs are very high - e.g. regulation subsidies state provision and price controls all have high costs for enforcing and administrating.
  3. Regulatory capture - when regulating monopoly power interests of society are overlooked for interest of CEO
  4. Unintended consequences - black markets , impact on poor and firms , employment and firms becoming dependant on subsidies
• Consequences of Government failure

  1. The intervention may not have any effect on supply and demand.

  2. The intervention may have costs that lead to an opportunity cost of not being able to pay for other government projects.

  3. The intervention may lead to firms exiting the market, leading to unemployment or loss of an industry in the UK.

  4. The intervention may disincentivise firms from increasing production to the most efficient point.
• Causes of Government failure pt2

  4. Lack of profit incentive. Firms may not reduce their cost as there is no profit incentive as some interventions aim to eliminate profit made in a market.

  5. Regulatory capture. When regulators become overly sympathetic to the firms they are supposed to regulate.

  6. Moral hazard. Firms that are aware the government is willing to protect the market may make riskier decisions leading to bigger market failures.
• Subsidy

  Government payments to a producer to lower their costs of production and encourage them to produce more.
• Tradable pollution limits

  Licenses which allow businesses to pollute up to a certain amount. The government controls the number of licenses and so can control the amount of pollution. Businesses are allowed to sell and buy the permits which means there may be incentive to reduce the amount they pollute.
• Indirect tax

  Taxes on expenditure which increase production costs and lead to a fall in supply.
• Buffer stock schemes

  The introduction of both a maximum and minimum price in the market to prevent large fluctuations in prices.
• State provision

  When the government provides public goods or merit goods which are underprovided in the free market.
• Minimum price

  A floor price which a firm cannot charge below.
• Maximum price

  A ceiling price which a firm cannot charge above.
• Maximum Price

  A) Max price

  B) Quantity

  C) Price

  D) firm revenue

  E) producer surplus

  
• Minimum Price

  A) Min price

  B) Quantity

  C) Price

  D) Excess supply

  
• Tax:

  A) Consumer incidence

  B) producer incidence

  C) welfare loss

  
• Subsidy

  A) Producer incidence

  B) Consumer incidence

  
• Pollution Permits

  
• State Provision

  
• Effect of Indirect tax

  Increases cost of production

  leading to firm internalising externality ( polluter pays )

  Solves over consumption/production

  Promotes allocative efficiency whilist generating gov revenue

  The hypothecated tax can be used again to solve market failure
• Evaluation of indirect tax

  1. Price inelastic demand. Demand needs to be price elastic for indirect tax to work ( responsive )
  2. Setting tax at the right level. Assumption gov has perfect info of the value of the negative externality is wrong. leading to setting the level of tax wrong and so externality won't be internalised
  3. Regressive. Tax takes larger portion of poor income. Failure as Gov macro objective is equity in distribution of income.
  4. Black markets. Cig black market valued at 2 billion a year. Black market need more policing -> costly -> gov failure.
• Effect of Subsidy

  Lowers cost of production

  decreases price and increases quantity

  Solves under consumption/production

  Allocative efficiency and welfare gain
• Evaluation of Subsidy

  1. Cost - Subsidies need to go to everybody in the industry -> increase in cost
  2. Setting subsidy @ right level - very likely gov lacks information and so under subsidise -> not solve Market F . Over subsidise -> cost increase gov failure and encourage subsidy dependancy.
  3. How firms use subsidy - don't have to use it to decrease cost of production -> LR dependancy and x-inefficient
  4. Price inelastic demand . For subsidy to work there needs to be price elastic demand e.g. buses ppl who drive don't want to swap due to inconvenience not just price reasons
• Regulation - Non market based approach. 


  Command ( rules/laws ) - bans , limits , caps ( emission caps ) , compulsory, innovative regulation like deposit recycling scheme.

  Control - strong enforcement of regulation or no incentive to follow it . Effective punishment e.g. fines and jail term. There is an incentive to to follow regulation .

  They lead to incentive to change behaviours e.g. consumer produce more or less to move quantity to solve issue in the free market.

  Allocative efficiency and welfare gain
• Evaluation of Regulation

  1. Costs - regulation is very costly administration costs like drawing up rules very costly and enacting regulation is costly. If the cost cannot be afford by the gov reg is going to be poor and as control won't exist
  2. Setting right regulation ( Command ) - if set too strict reduces profitability. Firms will find ways to cheat and not follow -> gov failure. If too lax lack of incentive to follow .