1.4.1 - Government intervention in markets

• Types of Goverment intervention

  • taxes
  • subsides
  • maximum prices
  • minimum prices
  • tradable pollution permits
  • provision of information
  • regulation
• Indirect taxes are taxes on expenditure. They increase production costs for producers, so producers supply less
• There are two types of indirect taxes:

  • Specific tax
  • Ad valorem taxes
• Ad valorem taxes are percentages, such as VAT, which adds 20% of the unit price.

  
• Specific taxes are a set tax per unit, such as the 58p per litre fuel duty on unleaded petrol.

  A) Paid by consumers

  B) Paid by producer

  
• A subsidy is a payment from the government to a producer to lower their costs of production and encourage them to produce more.
• Subsidies encourage the consumption of merit goods. This includes the full social benefit in the market price of the good. Therefore, the external benefit is internalised

  
• The government might set a maximum price where the consumption or production of a good is to be encouraged. This is so the good does not become too expensive to produce or consume.
• Maximum prices have to be set below the free market price, otherwise they would be ineffective.

  A) Max price

  
• Maximum prices could lead to welfare gains for consumers by keeping prices low, and they could increase efficiency in firms, since they have an incentive to keep their costs low to maintain their profit level. However, it could reduce a firm’s profits, which could lead to less investment in the long run. Moreover, firms might raise the prices of other goods, so consumers might have no net gain.
• The government might set a minimum price where the consumption or production of a good is to be discouraged. This ensures the good never falls below a certain price.
• Minimum prices would reduce the negative externalities from consuming a demerit good, such as alcohol. Minimum prices have to be set above the free market price, otherwise they would be ineffective.

  A) Min price

  
• Tax diagram showing consumer and producer burden

  A) consumer burden

  B) producer burden

  C) specific

  
• Subsidies diagram showing consumer and producer benefit

  A) producer benefit

  B) consumer benefit

  C) subsidy

  
• Tradable pollution permits allow the farm to pollute a specific amount of pollution, the goverment also reschricts the amount of permits sold
• Companies have to buy permits in order to pollute so, in an attempt to cut costs and increase profit, companies may use greener technology
• Disadvantage of subsidies

  • decreases profit motive so increases inefficiency or firms
  • high opportunity cost
  • high excess demand
  • increases reliance on the government