gov interventions

• Government failure is when the costs of government intervention in a market outweighs the benefits that come from an intervention
• Government failure results in a worsening of the allocation of scarce resources and a worsening of social welfare
• Even if there is a pre-existing market failure, government intervention may not be the best solution due to the risk of government failure
• Government failure


  When the costs of government intervention in a market outweighs the benefits that come from an intervention
• Considering government failure


  1. Evaluate whether the benefits of government intervention exceed the costs

  2. If the costs exceed the benefits, then government intervention may not be worthwhile
• Causes of government failure

  • Lack of full information for policymakers
  • High costs of policy administration and enforcement
  • Unintended consequences of policies
  • Regulatory capture
• Governments and policymakers may lack the full information required to make effective policy decisions, especially when valuing externalities
• Policies such as regulation, subsidies, state provision, and price controls can have high administrative and enforcement costs, which can outweigh the benefits
• Unintended consequences of policies, such as the creation of black markets or negative impacts on firms and employment, can lead to government failure
• Regulatory capture occurs when the interests of industry players are prioritised over the interests of society, leading to ineffective regulation and government failure
• Indirect taxation


  Taxes and increases of firms' costs of production that can be transferred to the consumer via a higher price
• Negative externality


  Overconsumption and not overproduction taking place
• Using indirect taxation to solve negative externality in production

  1. Increase firm's costs of production

  2. Marginal private cost curve shifts left

  3. New equilibrium at lower quantity
• Using indirect taxation to solve negative externality in consumption

  1. Increase firm's costs of production

  2. Marginal private cost curve shifts left

  3. New equilibrium at lower quantity
• Indirect tax increases costs of production for firms, shifting the MPC curve
• Internalising the externality


  The externality is being accounted for in the prices being paid
• Indirect tax generates government revenue
• Hypothecated tax


  Tax revenue is ring-fenced to further solve the market failure
• If demand is price inelastic


  Indirect tax may not reduce quantity enough to solve the market failure
• Governments do not have perfect information to set the optimal tax level
• Overtaxing can lead to black markets, smuggling, and regressive impacts on the poor
• Undertaxing will not fully internalise the externality
• Regressive tax


  Takes a greater proportion of income from the poor than the rich
• Indirect taxation can promote black markets
• Paternalistic


  Government forcing consumers to do what it wants by raising prices
• Indirect taxation can impinge on individual freedom and choice, especially if the market failure is not significant
• Subsidy


  Money grant given to producers by the government to lower cost of production and encourage an increase in output or quantity
• Market failures solved by subsidies


  • Under-consumption
  • Under-production
• Subsidy


  Lowers costs of production, shifts marginal private cost curve to the right
• Shift in marginal private cost curve due to subsidy

  Increases quantity, reduces price
• Subsidies are very costly to the government
• Cost of subsidy to government


  Vertical distance between old and new marginal private cost curves multiplied by the new equilibrium quantity
• Subsidies financed by borrowing can lead to future tax rises and spending cuts
• Subsidies create opportunity cost as the money could have been spent more productively elsewhere
• Subsidies need to be given to all producers in the industry, increasing the overall cost
• Governments lack perfect information to set the optimal subsidy level
• Firms may not pass on the subsidy benefits to consumers through lower prices
• Subsidies can create long-run dependency for firms on government support
• Subsidies are most effective when demand is price inelastic
• Subsidies may not work well for products/services with price inelastic demand (e.g. public transport, fruit/vegetables, gym memberships)