1.4.1: Government Intervention in Markets

• Tragedy of the commons: When no one owns a resource e.g forests, people overuse it and it causes environmental destruction
• Tradeable pollution permit: A permit that a firm can buy which allows them to pollute a certain amount
• Companies can sell tradeable pollution permits to each other, incentivising them to pollute less as they can increase revenue
• Indirect tax: Tax imposed on producers by the government. It can be passed onto consumers
• Incidence of tax: How the final tax burden is shared between producers and consumers
• For indirect taxes, consumer burden is represented by the top rectangle while producer burden is represented by the bottom rectangle
• If demand is price elastic, indirect tax falls mainly on the producer because if they increase prices demand will decrease
• If demand is price inelastic, indirect tax falls mainly on the consumer because if they increase prices demand will not change by much
• Specific tax is shown by a parallel shift, while Ad valorem tax is shown by a shift with the shifted curve having a steeper gradient
• Advantage of indirect taxes: Corrects market failures such as negative externalities
• Advantage of indirect taxes: Discourages consumption of demerit goods like tobacco
• Disadvantage of indirect taxes: Indirect taxes are regressive, so they affect those on lower incomes more
• Disadvantage of indirect taxes: Firms might evade taxes, and there may be unintended consequences, leading to government failure
• Producer subsidies: Payments to producers by the government to reduce their cost of production, and encourage them to decrease prices
• Consumer subsidies: Payments to consumers to incentivise them to purchase more of a good
• For subsidies, consumer benefit is shown by the bottom rectangle and producer benefit is shown by the top rectangle
• If demand is elastic, the subsidy mainly benefits the producer as they will not have to decrease price by much to get a big increase in demand
• If demand is inelastic, the subsidy mainly benefits the consumer, as the producer has to decrease prices by a large amount to gain an increase in demand
• Advantage of producer subsidies: Corrects market failures e.g positive externalities
• Advantage of producer subsidies: Encourages innovation and investment
• Advantage of producer subsidies: Protects consumers' income and jobs
• Disadvantage of producer subsidies: Costs the government revenue which could be spent elsewhere
• Disadvantage of producer subsidies: Firms have less incentive to be productive, and may become over reliant on the subsidy
• Disadvantage of producer subsidies: Firms could distribute extra profit to shareholders rather than invest it
• Maximum price: When the government sets a price at which a good cannot be charged above
• Reason for using maximum prices: To make necessary goods more affordable
• Reason for using maximum prices: Encourage consumption of goods that are good for social welfare
• Consequence of maximum prices: Causes a shortage of the good
• Consequence of maximum prices: Causes disequilibrium as the price will be too low, causing excess demand
• Consequence of maximum prices: Potential for government failure
• Government revenue is consumer burden + producer burden
• For subsidies, government loss is consumer benefit + producer benefit
• Problem with maximum prices: Suppliers may leave the market if they cannot charge high enough to make profit
• Problem with maximum prices: The government could use subsidies or provision of information instead, which gives firms more freedom
• Minimum price: A price set by the government which producers cannot charge below
• Reason for minimum prices: To support income and jobs of producers
• Reason for minimum prices: To discourage consumption of demerit goods or goods which are bad for social welfare
• Reason for minimum prices: To prevent consumers abusing monopsony power they have over suppliers
• Consequence of minimum prices: Causes excess supply of the good
• Consequence of minimum prices: Loss of price functions as incentive and signalling can no longer take place