1.4.1 Government intervention

• Why do governments interveneProviding healthcare and education, which the free market would underprovide

  • To correct market failures
• Indirect taxes


  Taxes on expenditure that increase production costs for producers, so producers supply less, increasing market price and reducing demand
• Indirect taxes


  • £1 tax per packet of cigarettes
• Types of indirect taxes

  • Ad valorem taxes (e.g. VAT)
  • Specific taxes (e.g. fuel duty)
• Ad valorem taxes


  Percentages, such as VAT, which adds 20% of the unit price
• Incidence of ad valorem tax

  Depends on price elasticity of demand - for inelastic goods like cigarettes, consumers bear larger burden
• Ad valorem taxes raise more revenue if demand is price inelastic, as demand falls only slightly with the tax
• Specific taxes


  A set tax per unit, such as the 58p per litre fuel duty on unleaded petrol
• Indirect taxes


  Could reduce quantity of demerit goods consumed by increasing price, internalising the externality
• Subsidy


  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 by including the full social benefit in the market price
• Subsidies


  • Subsidising recycling schemes to make it cheaper for consumers to recycle waste
• Maximum price


  A price set by the government where the consumption or production of a good is to be encouraged, below the free market price
• Maximum prices prevent monopolies exploiting consumers, but could lead to government failure if the optimum price is misjudged
• Maximum prices


  Can lead to welfare gains for consumers by keeping prices low, but may reduce firm profits and investment in the long run
• Minimum price


  A price set by the government where the consumption or production of a good is to be discouraged, above the free market price
• Minimum prices


  • Minimum price on alcohol, National Minimum Wage
• Minimum prices reduce negative externalities from consuming demerit goods
• Tradeable pollution permits


  Limit the amount of negative externalities, in the form of pollution, created in industries, allowing firms to buy and sell allowances
• State provision of public goods

  The government provides public goods underprovided in the free market, such as education and healthcare, which have external benefits
• State provision of public goods can be expensive for governments and incur opportunity costs
• Provision of information


  The government provides information to ensure no information failure, so consumers and firms can make informed decisions
• Provision of information


  • Requiring second-hand car dealers to reveal a car's full history
• Providing information can be expensive to police
• Regulation


  The government uses laws to ban or mandate certain consumer or firm behaviours
• Regulation


  • Minimum school leaving age, compulsory recycling schemes
• Regulation can raise costs for firms who may pass them on to consumers, but fines can act as a disincentive to break rules
• Government failure


  When government intervention worsens market failure or creates a new failure, resulting in a net welfare loss
• Causes of government failure

  • Distortion of price signals
  • Unintended consequences
  • Excessive administrative costs
  • Information gaps
• Government subsidies could distort price signals and lead to inefficient resource allocation
• Unintended consequences can undermine government policies and make them expensive to implement
• The social benefits of a policy may not be worth the financial cost of administering it
• Lack of perfect information can lead to assumptions and poor policy decisions