1.4.1 Government intervention in markets

• Government policies to intervene in markets

  1) Indirect taxes

  2) Subsidies

  3) Minimum prices

  4) Maximum prices

  5) Regulation

  6) Pollution permits

  7) State provision of goods & services

  8) Information provision
• Indirect tax:


  A tax on consumer expenditure, e.g. VAT or taxes on specific goods (excise taxes) such as alcohol.

  They are indirect because the seller is responsible for paying the tax to the govt but consumers pay at least part of the tax indirectly through higher prices.
• Specific tax:


  An indirect tax per unit or per volume.
• Ad valorem tax:


  An indirect tax levied as a percentage of the value of the good.
• How can indirect taxes resolve market failure? *

  Production of a good has -ve externalities -> it will be overproduced, causing market failure. -> indirect tax will ↑costs and ↓supply -> leads to ↑price -> contraction in D and reduction in q -> reduces overproduction and solve market failure.

  -Internalise the externality
• Problems of using indirect taxes to solve market failure

  -Difficult to calculate the value of the external cost and therefore it is difficult to know how much of the good is overproduced. Therefore, it is difficult for the govt to set the tax at the correct level to fully solve the market failure.

  -If PED is inelastic, then the % ↑ in P caused by the tax will lead to a smaller % ↓ in Qd. Therefore, overconsumption may remain

  -Indirect taxes are regressive.
• Subsidy:


  Grant from the government to firms in order to lower costs and encourage production.
• How can subsidies be used to solve market failure?*

  If a good has +ve externalities -> it will be underproduced, causing market failure. -> subsidy will ↓ costs and ↑ supply -> leads to ↓ in P -> extension in D and increases q -> reduces underproduction and solves market failure.
• Problems of using a subsidy to solve market failure

  -Opportunity cost for the govt

  -Difficult to calculate the value of the external benefit and therefore it is difficult to know how much of the good is underproduced. Therefore, it is difficult for the govt to set the subsidy at the correct level to fully solve the market failure.

  -Subsidies can make firms inefficient as the become reliant on the govt subsidy to remain competitive.
• Maximum price (AKA price ceiling):


  The highest price that can be legally set for a good, e.g. energy prices in the UK.

  
• Minimum price (AKA price floor):


  The lowest price that can be legally set for a good, e.g. alcohol prices in Scotland.

  
• Adv (+) and disadv (-) of maximum price to solve market failure

  (+): Reduce the prices of essential goods (e.g. electricity/gas) -> ↑ consumer surplus & reduces poverty.

  (-): As price is forced below equilibrium price -> there may be a shortage (demand exceeding supply) -> some consumers may become worse off as they are unable to consume the good.

  (-): May lead to black markets -> higher prices

  (-): May reduce revenue and profits of firms
• Adv (+) and disadv (-) of minimum price to solve market failure

  (+): Can be imposed on goods with negative externalities (e.g. alcohol). Minimum price increases price -> demand contracts -> reduces overconsumption -> market failure solved.

  (-): Forces price above equilibrium price -> leads to a surplus.

  (-): Opportunity cost for govt as they need to ensure that producers are not selling the good below the min price.
• Regulation:


  Rules/laws from the government used to solve market failure.

  E.g. banning new petrol cars to reduce negative externalities, or forcing firms to clearly label sugar & fat content on food packaging to reduce information gaps.
• Adv (+) and disadv (-) of regulation to solve market failure

  (+): Easy to understand & cheap to enforce

  (+): Firms are likely to comply as failure to follow the regulation can lead to fines.

  (-): Opportunity cost of enforcement

  (-): With pollution caps/limits it is difficult to set them to the correct level.
• Tradable pollution permits:


  Schemes that set a limit on a particular type of pollution, and then issue pollution permits which can be bought and sold between firms.
• Adv (+) and disadv (-) of tradable pollution permits to solve market failure

  (+): Discourages high-polluting production processes as firms will have to avoid having to buy additional permits which will add to their costs.

  (+): Encourage low-polluting production processes as firms with excess permits can sell them to generate additional rev

  (-): Opportunity cost of enforcement

  (-): Difficult to decide how many permits to issue.
• State provision of goods and services:


  When the government directly provides a good rather than the good being provided by the private sector.
• Adv (+) and disadv (-) of state provision to solve market failure

  (+): Public goods, e.g. streetlights, need to be provided by the govt as private sector will not provide them due to the free-rider problem.

  (+): Govt also often produces goods with positive externalities, e.g. education and healthcare.

  (-): Opportunity cost

  (-): Public sector is less efficient than the private sector as govt is not motivated by profits, so costs are higher.
• Provision of information:


  When the government either runs an information campaign (e.g. TV adverts about the dangers of drinking and driving) or when the government forces private firms to provide more information about their products (e.g. forcing cigarette producers to put warnings on packets).
• Adv (+) and disadv (-) of information provision to solve market failure

  (+): Removes information gaps

  (+): Can encourage consumers to reduce consumption of goods with -ve externalities, therefore solving market failure.

  (-): Opportunity cost

  (-): Consumers may ignore the info (e.g. cigarettes are addictive).