gov intervention

• Government intervention


  Governments intervene in the market to correct market failure
• Government intervention


  • Providing healthcare and education
• Indirect taxes


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


  • Ad valorem taxes (percentages, e.g. VAT)
  • Specific taxes (set tax per unit, e.g. fuel duty)
• Incidence of tax


  How the tax burden is shared between consumers and producers, depending on price elasticity of demand
• Demand is price inelastic


  Consumers bear larger burden of indirect tax
• Demand is price elastic


  Producers bear larger burden of indirect tax
• Indirect taxes could reduce quantity of demerit goods consumed by increasing price</b>
• Subsidies


  Payments from government to producers to lower their costs and encourage more production
• Subsidies


  Shift supply curve to the left, increasing quantity produced and reducing price
• Consumers gain more from subsidies


  When demand is price inelastic
• Producers supply more with subsidies


  When demand is price elastic
• Disadvantages of subsidies


  • Opportunity cost to government
  • Potential for firms to become inefficient
  • Government failure
• Maximum price


  Government sets a maximum price to encourage consumption or production of a good
• Maximum price set


  Below free market equilibrium price
• Maximum prices prevent monopolies exploiting consumers
• Minimum price


  Government sets a minimum price to discourage consumption or production of a good
• Minimum price set


  Above free market equilibrium price
• Minimum prices could reduce negative externalities from consuming demerit goods
• Minimum wage


  Leads to fall in employment rate
• Minimum wage provides incentive to work and increases standard of living of poorest
• Tradeable pollution permits


  Limit amount of pollution firms can create, with surplus permits tradable
• Advantages of tradeable pollution permits


  • Benefit environment long-term
  • Government revenue from selling permits
  • Incentive for greener production
• Disadvantages of tradeable pollution permits


  • Firms may relocate to avoid limits
  • Higher costs passed to consumers
  • Barrier to entry for new firms
  • Expensive to monitor
• State provision of public goods


  Government provides goods with external benefits that are underprovided in free market, e.g. education and healthcare
• State provision of public goods can be expensive for government
• Provision of information


  Government ensures no information failure so consumers and firms can make informed decisions
• Provision of information can be expensive to police
• Market failure


  When the free market fails to allocate resources to the best interests of society, so there is an inefficient allocation of scarce resources
• Regulation


  Government uses laws to ban or mandate certain consumer or firm behaviours
• Economic and social welfare is not maximised where there is market failure
• Types of market failure


  • Externalities
  • The under-provision of public goods
  • Information gaps
• Regulation can raise costs for firms who may pass this on to consumers
• Government failure


  When government intervention worsens market failure or creates new failures, resulting in net welfare loss
• Externality


  The cost or benefit a third party receives from an economic transaction outside of the market mechanism
• Causes of government failure


  • Distortion of price signals
  • Unintended consequences
  • Excessive administrative costs
  • Information gaps
• Public goods


  Non-excludable and non-rival, and they are underprovided in a free market because of the free-rider problem
• Distortion of price signals from government subsidies can lead to inefficient allocation of resources
• Information gaps


  Consumers and producers have imperfect information when making economic decisions, leading to a misallocation of resources
• Unintended consequences can undermine government policies and make them expensive to implement