1.4

Question 1

Government intervention is when the state

Answer 1

Gets involved in markers and takes action to correct market failure, improve economic efficiency and change the distribution of income and wealth

Question 2

What can governments use to change price signals, get better information or change resource allocation?

Answer 2

Regulations, taxes, subsidies, max and min prices to change price signals,

Direct provision to change resource allocation

Question 3

Main reasons for government intervention

Answer 3

• To correct for one or multiple market failures.
  • To achieve a more equitable final distribution of income and wealth.
  • To improve the performance of the macroeconomy i.e. reduce unemployment or stimulate growth

Question 4

Fiscal policy can be used to alter the level

Answer 4

Of demand for different products and the pattern of demand.

Question 5

How can indirect taxes be used to alter the level of demand

Answer 5

Indirect taxes can be used to raise the price of de-merit goods and products with negative externalities designed
to increase the opportunity cost of consumption and thereby reduce demand towards a socially optimal level.

Question 6

How can subsidies be used to alter the level of demand

Answer 6

Subsidies to consumers will lower price of merit goods. They are designed to boost consumption and output
of products with positive externalities
– remember that a subsidy causes an increase in market supply and leads
to a lower equilibrium price.

Question 7

How does tax relied alter the level of demand

Answer 7

government may offer financial assistance such as tax creditsfor business investment in research
and development. Or a reduction in corporation tax (a tax on company profits) designed to promote new capital
investment and extra employment.

Question 8

Evaluation on Government Intervention

Answer 8

• value judgements
• changing prices
• combination of polices
• power of markets?
• costs and benefits
• law of unintended consequences

Question 9

help your evaluation of government intervention in an exam – it may be helpful to consider these questions:

Answer 9

• efficiency of a policy
• effectiveness of a policy
• equity effects of intervention
• sustainability of a policy
• does the policy need to be used alongside something else

Question 10

4 reasons why implementing taxes is difficult

Answer 10

• setting the correct tax rate
• cost of collection
• inelastic demand
• Increased costs

Question 11

Arguments in favour of a sugar tax

Answer 11

1. External costs of consuming sugary drinks – are a cause of market failure
2. Information failures – people under-estimate the long-term costs of their consumption
3. Sugar tax raises revenue – ring-fenced for other projects e.g. to help fund school sports / breakfast clubs
4. Tax encourages manufacturers to re-formulate and offer healthier
   alternatives e.g. in vending machines

Question 12

Arguments against a sugar tax

Answer 12

1. Might be regressive on lower income families – i.e. the tax might be inequitable
2. Other policies might be more effective in cutting consumption in the long-term (e.g. better information)
3. People might simply switch to other sugary products = ineffective
4. Risk of lost jobs in pubs and shops that rely heavily on drink sales

Question 13

Exam hint: Always worth stating that marginal social costs are

Answer 13

Difficult to measure - can make it hard to assign the right level of taxation to correct for externalities and overcome the market failure

Question 14

Are subsidies effective in meeting their aims?

Answer 14

o Will they achieve the desired stimulus to demand / consumption?
o Is a subsidy sufficient? Might other incentives be needed to change behaviour e.g. some “nudges”

Question 15

Will a subsidy affect productivity / efficiency?

Answer 15

o Subsidies for investment and research can bring positive spill overs
o But firms may become dependent on state aid / financial assistance and innovate less over time

Question 16

How much does a subsidy cost and who benefits?

Answer 16

o Is a subsidy part self-financing? Will it create more tax revenue?
o Or does a subsidy create an expensive extra burden for taxpayers who may not have benefitted and therefore be inequitable?

Question 17

What is a maximum price?

Main aim, how to set price effectively

Answer 17

• legally imposed maximum price in a market that suppliers cannot exceed.
- A maximum price is introduced in an attempt to prevent price from rising above a certain level.
• aim of max is equity so that goods are more widely available to the general population.
• To be effective as a form of intervention, a maximum price has to be set below the existing free market equilibrium price

Question 18

If quantity is restricted,then some consumers will be willing to pay

Answer 18

A higher ‘unofficial’ price , so producers can extract extra consumer surplus at higher price

Question 19

Question: Assess the case for introducing rent controls in the UK

Answer 19

• rent controls are form of max price
• to be effective in changing resource allocation, needs to be set below normal equilibrium price
• effects of rent control shown in diagram
• as a result of capped R2, demand expands, so is more affordable
• see from diagram that supply decreases
• = disequilibrium as shortage due to excess demand

Question 20

What is a minimum price?

Answer 20

price floor

It is a legally imposed price floor below which the normal market price cannot fall. To
be effective, a minimum price has to be set above the normal equilibrium price.

Question 21

Many environmental economists recommend applying the polluter pays

Answer 21

principle and placing a price on carbon dioxide and other greenhouse gases

Question 22

What is carbon emissions trading?

Answer 22

• uses the market mechanism to change relative prices and the incentives
• Businesses need to buy enough emissions allowances – the higher the price, the greater the incentive to cut pollution
• Carbon trading provides a quantity adjustment to CO2 emissions

Question 23

increasing the scarcity of carbon permits leads to an increase in

Answer 23

price

= more expensive to emit carbon, so capital investment into low carbon tech

Question 24

Advantages of a carbon tax

Answer 24

1. A pollution tax internalizes the externality and makes the polluter pay
2. A tax raises extra revenue which can be ear-marked for other use

Question 25

Disadvantages of a carbon tax

Answer 25

1. Low price elasticity of demand | 2. Risk of higher structural unemployment among workers in carbon intensive sectors such as mining, oil and gas

Question 26

Pure public goods are usually provided – perhaps to a basic standard – by the state on the grounds of:

Answer 26

Fairness Efficiency Social welfare

Question 27

Provision of Information

Answer 27

- health warnings - nutritional labelling - gamble aware - industry standards

Question 28

Regulation to correct externalities

Answer 28

- smoking bans - minimum age - max co2 emissions - speed limits

Question 29

What is Government Failure?

Answer 29

• When government intervention in market leads to less efficient allocation of resources and makes situation worse • government intervention to correct market failure leads to a net social welfare loss. costs> benefits

Question 30

3 words that government intervention can be

Answer 30

- ineffective - inequitable - misplaced

Question 31

Examples of unintended consequences:

Answer 31

- Bank bail-outs – raises the problem of moral hazard | - Import tariffs on steel – hits domestic car and construction firms

Question 32

What is regulatory capture?

Answer 32

* Regulatory capture is a form of government failure * It happens when a government agency operates in favour of producers rather than consumers * This often happens when suppliers have significant lobbying power e.g. with government agencies

Question 33

main causes of regulatory capture?

Answer 33

• Asymmetric information – regulators may rely on critical information supplied by regulated firms themselves about costs, investment requirements • Under-resourced – regulatory agencies may not have enough funding to scrutinize an industry properly • Information gaps – people working for a regulator may not understand the complexities of an industry e.g. financial services – they may not understand risk

Question 34

Why does regulatory capture matter?

Answer 34

1. Consumers interests may be harmed if regulators fail to hold suppliers to account and enforce minimum standards of service 2. Prices will be higher leading to lower real incomes and regressive effects on lower income households 3. There can be damaging externalities if the regulator fails to act leading to a social welfare loss

Question 35

Key revision points about government failure:

Answer 35

1. Free market economists are distrustful of intervention. They believe price mechanism should operate. 2. Often, we accuse the government of policy failure only with hindsight. 3. Limited information - no government has the resources and information available to it to make fully informed, objective judgements. 4. Government failure is most likely to occur when decisions are made in the vested interest of special interest groups, at the expense of other groups.

Question 36

How could taxes affect consumption of goods with negative externalities

Answer 36

Indirect taxes could reduce the quantity of demerit goods consumers, by increasing the price of the good. If the tax is equal to the external cost of each unit, then the supply curve becomes MSC rather than MPC, so free market equilibrium becomes the socially optimum equilibrium This internalises the externality, so the polluter pays for the damage

Question 37

In theory how could could taxation affect consumption of demerit goods

Answer 37

Discourage consumption and reduce negative externalities as it is more expensive

Question 38

How do subsidies affect consumption of merit goods

Answer 38

Encourage consumption of merit goods, includes full social benefit in the market price of the good, so external benefit is internalised

Question 39

Disadvantage of subsidies

Answer 39

Opportunity cost to the government + risk of firms becoming inefficient if they rely on the subsidy + government failure if they subsidies less efficient industries

Question 40

Maximum price

Answer 40

Government might set a maximum price where the consumption or production of a good is to be encouraged. This is so good doesn’t become too expensive to produce or consume - max prices have to be below free market price - prevent monopolies exploiting consumers

Question 41

Benefits of maximum price

Answer 41

could lead to welfare gain for consumer by keeping prices low could increase efficiency in firms as they have incentive to keep their costs low to maintain profit level

Question 42

Cons of maximum proce

Answer 42

Could reduce firms profits, could lead to less investment in long run Firms could raise prices of other goods, so consumers have no net gain

Question 43

Minimum price

Answer 43

Minimum price when consumption or production of a good is to be discouraged Reduced negative externalities from consuming a demerit food Above free market price

Question 44

Advantages of tradeable pollution permits

Answer 44

- should benefit environment in the long run, by encouraging firms to use green production methods - the government could raise revenue from the permits, because they can sell them to firms, this revenu could then be reinvested in green technology - if firms exceed permit, they will have to buy permit from firms that did not use whole permit, this raises revenue for greener firms

Question 45

Disadvantages of tradeable pollution permits

Answer 45

- but it could lead to firms relocating to where they can pollute without limits to reduce production costs - firms might pass higher costs of production onto consumer - competition could be restricted in the market if permits create a barrier to entry for potential firms - it could be expensive for governments to monitor emissions

Question 46

State provision of public goods

Answer 46

- government could provide public goods which are under provided in the free market, such as education and healthcare - this makes merit goods more accessible, which might increase their consumption and yield positive externalities - it could be expensive for governments to provide education, and government will incur an opportunity costs of spending revenue

Question 47

Provision of information

Answer 47

- by providing info, government can ensure there is no info failure, so informed economic decisions can be made - eg, governments might make it illegal for second hand car dealers not to reveal entire history of a car, so consumers know what they are buying - can be expensive to police

Question 48

Regulation

Answer 48

- government could use laws to ban consumers from consuming a good - eg, minimum school leaving age is 26 - positive externalities from laws (eg skilled workforce) - firms which fail to follow are fined, which disincentives them - potentially raises costs of firms, who might pass higher costs to consumers

Question 49

Causes of government failure

Answer 49

- distortion of price signals - unintended consequences - excessive administrative costs - information gaps

Question 50

Distortion of price signals

Answer 50

- government subsidies could distort price signals by distorting free market mechanism, could be inefficient allocation of resources because market mechanism not able to act free;t

Question 51

Unintended consequences

Answer 51

- this is when actions of producers and consumers have unexpected, or unintended consequences

Question 52

Excessive administrative costs

Answer 52

Social benefits of a policy might not be worth the financial cost of administering the policy. It might cost more than the government anticipated, the government has to consider whether the policy is a good value for money

Question 53

Information gaps

Answer 53

- some policies might be decided without perfect info, might require a full cost-benefit analysis, which is time consuming and expensive - eg, government policies are long term and have failed several times in the past - however it is impractical for government to gain every bit of info they need, so assumptions are made

Question 54

Example of ETS

Answer 54

EU ETS 05, led to 21% reduction in GhG emissions

Question 55

Advantages of state provided public goods

Answer 55

● This ​corrects market failure by providing important goods which would otherwise not be provided. It will lead to improved social welfare. ● It can help to bring about ​equality,​ by ensuring everyone has access to basic goods. ● There will be ​benefits of the goods themselves​, for example by providing healthcare, the government ensures that the workforce is healthy and so this canimprove economic growth. ● By using competitive tenders (looked at in Theme 3), the government can ensure efficiency

Question 56

Disadvantages of state provided public goods

Answer 56

● This is ​expensive and represents a ​high opportunity cost ​for the government. Administration costs are a problem ● Since the market is not involved, the government may produce the ​wrong combination of goods as consumers can not indicate their preferences. ● The government may be ​inefficient at production since they have no incentive to cut costs. ● Government officials may suffer from ​corruption and conflicting objectives

Question 57

Advantages of provision of information

Answer 57

● This helps consumers to act​ rationally,​ which allows the market to work properly. ● It is best if the government uses this ​alongside other policies​. For example, it can make demand more elastic in the long run and so help indirect taxes to become more effective at reducing output

Question 58

Disadvantages of provision of information

Answer 58

● This can be ​expensive​ for the government to do, incurring an opportunity cost. ● The government themselves may not always have all the information, so it may bedifficult to inform consumers. ● Consumers may ​not listen ​to the information provided due to irrational behaviour

Question 59

Advantages to regulation

Answer 59

● This can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed. This will help to overcome market failure and maximise social welfare

Question 60

Disadvantages to regulation

Answer 60

● Laws may be ​expensive​ for the government to monitor, incurring an opportunity cost. ● Compared with tradable pollution permits, regulation is a ​less efficient method of reducing pollution. ● The government can suffer from ​regulatory capture​ (looked at in Theme 3). ● Firms may ​pass on costs​ to the consumer in the form of higher prices. ● Excessive regulation may reduce competition in a market and efficiency, byincreasing bureaucracy and reducing innovation