government intervention

• Governments intervene in the market to correct market failure
• Indirect taxes


  Taxes on expenditure that increase production costs for producers, so producers supply less, which increases market price and demand contracts
• Types of indirect taxes

  • Ad valorem taxes (percentages, such as VAT)
  • Specific taxes (set tax per unit, such as fuel duty)
• Incidence of tax


  Producers could make consumers pay the whole tax, or producers could pay part of the tax

  
• The incidence of the tax

  Depends on the price elasticity of demand of the good
• Government revenue from ad valorem taxes is larger if demand is price inelastic
• Subsidies


  Payments from the government to a producer to lower their costs of production and encourage them to produce more
• Subsidies encourage the consumption of merit goods by including the full social benefit in the market price of the good
• Subsidy


  Shifts the supply curve to the right, more of the merit good is produced and the price falls
• Consumers gain more from the subsidy when demand is price inelastic, whilst producers supply more when demand is price elastic
• Disadvantages of subsidies include the opportunity cost to the government, potential for firms to become inefficient, and the market to become reliant on subsidies and government failure
• Maximum price


  A price set by the government where the consumption or production of a good is to be encouraged, set below the free market price
• Maximum price


  Prevents monopolies exploiting consumers, but could lead to government failure if the optimum market price is misjudged
• Minimum price


  A price set by the government where the consumption or production of a good is to be discouraged, set above the free market price
• Minimum prices would reduce the negative externalities from consuming a demerit good
• Buffer stock systems


  Governments buy up harvests during surpluses, then sell the goods onto the market when supplies are low to smooth out price fluctuations
• Advantages of buffer stock systems

  • Farmer incomes remain stable
  • Increases consumer welfare by ensuring prices are not in excess
• Disadvantages of buffer stock systems

  • Governments might not have the financial resources
  • Farmers might overproduce
  • Storage is difficult and expensive
• Regulation


  The government using laws to ban consumers from consuming a good or make it illegal not to do something
• Regulation has positive externalities in the form of a higher skilled workforce
• Firms which fail to follow regulations could face heavy fines, which acts as a disincentive to break the rule
• Tradeable pollution permits


  Firms are allowed to pollute up to a certain amount, and any surplus on their permit can be traded
• Advantages of tradeable pollution permits

  • Benefits the environment in the long run
  • Government can raise revenue from selling permits
  • Encourages firms to use green production methods
• Disadvantages of tradeable pollution permits

  • Firms might relocate to where they can pollute without limits
  • Firms might pass higher costs onto consumers
  • Could restrict competition
• State provision of public goods

  The government providing public goods which are underprovided in the free market, such as education and healthcare
• State provision of public goods makes merit goods more accessible, which might increase their consumption and yield positive externalities
• Provision of information


  The government providing information to ensure there is no information failure, so consumers and firms can make informed economic decisions
• Governments can fail when they intervene in markets, which could worsen the market failure already present or create a new failure, resulting in a net welfare loss to society
• Mixed economy


  An economic system where the market is controlled by both the government and the forces of supply and demand
• Advantages of government intervention

  • Easier to coordinate resources in times of crises
  • Can compensate for market failure
  • Can reduce inequality and maximise welfare
  • Can prevent abuse of monopoly power
• Disadvantages of government intervention

  • Governments fail, as do markets
  • May not meet consumer preferences
  • Limits democracy and personal freedom(nanny state)
• Causes of government failure

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