Economics

• Ways government can intervene


  • Indirect taxes
  • Subsidies
  • Regulation
  • Pollution permits
  • Property rights
  • Provision of information
• Objectives of government microeconomic policy

  • Efficiency: to restore economic efficiency both allocative and productive efficiency
  • Equity: If markets are judged to be efficient they may not be judged to be equitable
• In theory, government intervention may reduce market failures. They increase the level of economic efficiency and may be judged to be desirable but govt. intervention could make the situation worse.
• Externality


  When the benefits or costs to society differ from the benefits or costs to the individual who is responsible for them
• Marginal social benefits (MSB's)


  Benefits to society
• Marginal private benefits (MPB's)


  Benefits to the individual
• Marginal social costs (MSC's)


  Costs to society
• Marginal private costs (MPC's)


  Costs to the individual
• Indirect tax


  1. Firm pays for the cost of polluting

  2. Cost has been internalised (paid for by the firm)
• Regulation


  1. Government passes laws to control the activities

  2. Payment to households for extreme blasting

  3. Clean up and restoration of surrounding lakes

  4. Policed and fines imposed for breaking the law

  5. Example: Exhaust fumes testing as part of warrant of fitness check
• Deregulation


  1. Removing laws that acted as a barrier to new firms entering the market

  2. Less govt. control

  3. Promotes competition

  4. Quality improves and prices decline

  5. Consumer welfare rises
• Pollution permit


  1. License from government that allows firms to pollute up to a certain level

  2. Permits can be purchased and sold

  3. Issued by government environmental agencies

  4. If firm pollutes less, remaining permit can be sold

  5. Initially supply of permits is fixed, vertical supply curve S0

  6. Demand for permits increases over time, demand curve shifts to D1

  7. Supply of permits reduced, supply curve shifts to S1

  8. Higher cost of permits forces firms to invest in greener technologies
• Criticisms of pollution permits: EU emissions trading scheme had oversupply of permits and low prices, giving firms no incentive to reduce emissions
• Property rights


  In a capitalist society, each person owns their assets and has property rights over them
• Property rights


  1. Firm polluting is asked to move, firm may refuse citing property rights and ask for compensation

  2. People affected by pollution may sue the firm or force it to move, exercising their property rights
• Negative consumption externalities


  Negative externalities caused by people, e.g. buying too many cars leading to traffic congestion, pollution, etc.
• Negative consumption externalities


  1. Equilibrium at P1 and Q1 where MPB=MPC

  2. Government imposes indirect tax, causing supply curve to shift left

  3. Price rises to P2 and quantity falls to Q0, the socially accepted level
• Positive production externalities


  1. Government provides a subsidy, causing supply curve to shift right

  2. Price falls to P2 and quantity rises to Q2

  3. Examples: skills training, free flu vaccinations
• Positive consumption externalities


  1. Equilibrium at F where MPC=MPB

  2. Adding marginal external benefits to MPB gives new demand curve MSB

  3. Government subsidises production, supply curve shifts from S1 to S2

  4. New equilibrium at H and Q2, prices lowered and suppliers happy to produce
• Government intervention, if handled correctly, can produce a more efficient allocation of resources, correct market failure, and bring about more social equality and equity.
• Nudge theory


  Presenting people with better choices so they make wiser decisions, without government intervention
• Nudge theory is like paternalism - telling others what to do against their will but having their best interest at heart.
• Advocates of nudge theory argue it is a way of achieving beneficial social and economic outcomes without government intervention.
• Nudge Theory


  A tool to correct market failure without government intervention, by presenting people with better choices so they make wiser decisions
• Nudge Theory


  • It is like paternalism - telling others what to do against their will but having their best interest at heart
  • The advocates argue it is a way of achieving beneficial social and economic outcomes without government intervention
• Nudge Theory examples


  • Free vaccination for over 60's against severe flu
  • Advertising campaigns to reduce exhaust emissions - promote public transport, cycling, etc.
• Nudge theory will work to some extent for people who are reasonable and rational, but not for those who are unreasonable and irrational
• Nationalisation


  The process by which governments takes private businesses into public ownership
• Privatisation


  A change in ownership of an activity from the public sector to the private sector
• Forms of privatisation


  • Direct sale of government owned and operated activities to private sector
  • Partial sale - government retaining 51% of shares & selling the rest to the private sector
  • Offering some shares to workers & the public
• Reasons for privatisation


  • Reduce government involvement in the economy
  • Give people opportunity to own shares
  • Benefits for consumers - prices – better service
  • Sale of the nationalised firms generates huge incomes for government
  • Private firms are more successful in obtaining loans to expand the business
• Reasons why privatisation may not always work

  • Some industries are best left to govt. provision – electricity etc.
  • Government will still provide the service even if it is making a loss, but private sector firms will not
  • Any profits will not be returned to government
  • To create a more equal society: provision of water services, etc. is for all citizens and not just the rich
• Disadvantages of nationalisation


  • X-inefficiency – the firm's costs rise and they pass on the increase to consumers in the form of higher prices
  • Managers do not have the freedom to manage the firm in a way that they see fit – they have to follow government rules
• Advantages of nationalisation


  • Some activities are best left to the government. Provision – electricity etc.
  • Government will still provide the service even if it is making a loss
  • Any profits will be returned to govt.
  • Provision of water services, etc. is for all citizens and not just the rich – there is a more equal society
• Reasons why government intervention fails

  • Problems of information - government could implement ineffective policies due to inaccurate information
  • Problems with incentives - government intervention can create undesirable incentives
  • Problems of policy conflict - policies aimed at efficiency may increase inequality
• Efficiency


  How scarce resources are best used to satisfy man's unlimited wants
• Equity


  Society distributes resources fairly among its people
• Fair distribution of income is not the same as equal distribution of income
• Horizontal equity


  Consumers with the same circumstances should pay the same level of tax
• Vertical equity


  Taxes should be fairly apportioned between the rich and the poor. Taxation system is progressive.