JUST GOVERNMENT INTERVENTION

Question 1

Reasons for taxes (4)

Answer 1

1) To adjust the supply curve: bc of neg externalities - to compensate third parties
2) to raise money to provide goods and services: positive externalities, public goods, merit goods
3) to reduce inequality
4) To pay for legal systems to enforce the law and regulations
5) to decrease demand e.g. cigarettes (demerit goods)

Question 2

what is a tax?

Answer 2

compulsory charge from government on individuals’ income, wealth or spending, and on firms’ profits or production
- to raise revenue and/or influence economic behaviour.

Question 3

Advantages of indirect tax

Answer 3

• Generates tax revenue which can be used to fund public services, or subsidies for positive externality goods, improving overall welfare
• Can target inelastic demerit goods (like cigarettes), giving large, stable tax revenue while still reducing consumption somewhat
• Relatively easy to collect from firms at point of sale and can be applied across many goods

Question 4

Problems with indirect tax

Answer 4

• Determining the rate of tax: may misestimate
• If demand is inelastic may not reduce the quantity consumed
• No apparent link between the tax collected and compensating
  those affected
• Tax evasion + black markets
• Administering and monitoring costs
• Often REGRESSIVE (poorer households spend a higher share of income on taxed goods = bear a heavier burden —> increases inequality)

Question 5

Conclusion about how effective a tax is

Answer 5

need to consider:
- how easy it is to identify the full social costs of a product
- how easy it is to quantify the cost
- how easy it is to enforce
- How much of a link is there between the revenue collected from the tax and the compensation of the affected third parties
- The global position → rates of other countries’ taxes

I Q L E G

Question 6

How does product tax affect a business and what does it depend on?

Answer 6

Reduces demand = revenue + profits fall
^ HOWEVER depends on level of tax, PED, how the market responds (any substitutes - may increase demand for alternatives)

Question 7

How to structure an answer to “discuss whether the government should use tax’s correct market failure in the … markets (12)”

Answer 7

1) define market failure + state why this specific market fails
2) Diagram
3) Why adding tax is good (e.g. moves supply)
4) Disadvantages e.g. enforcement, income distribution
5) Conclusion

Question 8

What are subsidies and why are they used

Answer 8

Payment to producers per unit of output
- used to encourage the production and consumption of merit goods with positive externalities
- shifts supply curve right to lower costs

Question 9

How do subsidies work?

Answer 9

Works with the market by adjusting supply (curve moves down)
- Increases output to where it should be if the external benefits were considered

Question 10

What is a regulation

Answer 10

a simple policy that sets requirements and rules for producers and consumers. It is backed by law (rule established by authority)

Question 11

Features of regulations/law

Answer 11

• usually has immediate effect
• Can affect both demand and supply
  Can deal with all sorts of market failure: lack of information, merit and demerit goods, externalities, public goods…

Question 12

Different types of regulations

Answer 12

• packing
• Design
• Manufacture
• Storage
• Marketing
• Sale
• Use of product
• Disposal of the product
  ^the lifecycle of product

Question 13

The effect of subsidies/grants on businesses

Answer 13

• Encourage demand and production (movement along the demand curve)
• Might increase profit margins
• May achieve EOS when the business produces more
• Will encourage more competitors into the market

Question 14

What does the effectiveness of the subsidy depend on?

Answer 14

• Elasticity of demand
• How easy it is to quantify the value of the positive externality
• The cost of the subsidy - how much production there will be (opportunity cost)
• Do foreign govs pay subsidies?
• Would another method be more effective?

Q C E G

Question 15

advantages of subsidies

Answer 15

• lower prices for consumers = demand increases
• Both consumers and producers gain: consumers pay a lower price, while producers raise total revenue and profits
• high profits + low risks encourage new firms to enter industry, invest in new capital and R+D
• keeps firms cost down to limit cost push inflationary presure

Question 16

What does the efficacy of a subsidy depend on?

Answer 16

1) elasticity of demand AND supply
2) how easy it is to quantify the value of the positive externalities
3) the cost of the Subsidy (how much production will it lead to)
4) do foreign governments pay similarlar Subsidies?
5) would another method be more effective?

Question 17

Disadvantages of a subsidy

Answer 17

• high costs (increase gov spending + puts pressure on budget)
• ^creates an opportunity cost for next best alternative forgone (cannot be spent on other priorities e.g. healthcare)
• inefficiency/reduced incentives (become dependent - reduces pressure to innovate, cut costs, improve productivity = takes focus from competition)
• Has to be administered (cost)
• Working out the level of subsidy is difficult
• Effects on income distribution (e.g. subsidies for electric cars - taking tax from the poor but only really benefits the rich)
• overproduction - creates Surpluses + allocative inefficiency (may increase pollution, wasted resource use + envir damage)

Question 18

Why does government pay for provisions?

Answer 18

The Government decided to provide a product/service because the failure is so acute
e.g. external benefits SO large the good would be massively under-consumed/produced that no other alternative would be sufficient

SO the Government takes over the supply curve

BECAUSE Governments focus on quality at the expense of cost AND businesses focus on reducing costs at the expense of quality

Question 19

Where does to money for government provisions come from?

Answer 19

Taxes (Government intervention)
Fees and charges
Government borrowing (+ printing money)

Question 20

Disadvantages to governmentnt provisions

Answer 20

• VERY HIGH OPPORTUNITY COST: resource wasted if doesnt work
• Productive inefficiency = no profit motive or competition (average costs higher than normal)
• Government failure: misallocate resources, under-invest = long waits + rationing
• Services constrained by tax revenue and political priorities = under‑provision of certain high‑cost services

Question 21

Advantages to government provisions

Answer 21

• reduces inequality: universal access to key public and merit goods
• sets output to socially optimal level (gov accounts for the external benefits)
• improve productive efficiency in the business as gov can use monopsony buying power to negotiate

Question 22

Alternatives to provisions

Answer 22

• subsidising
• information
• regulations
• paying private firms to lease assets e.g. hospitals

Question 23

Advantages of pollution permits (5)

Answer 23

• guaranteed cap on pollution = quantity of pollution controlled directly
  ^ (better than tax as output may not fall much if demand is inelastic)
• incentive for INNOVATION (production alternatives)
• incentive to reduce emissions: sell surplus permits (profit incentive) + heavy polluters face HIGHER costs
• gov revenue - fund public schemes + eco friendly objectives
• dynamic efficiency - gradually reduce no of permits

Question 24

Disadvantages of pollution permits (4)

Answer 24

• high costs for monitoring + enforcement = spend more money on inspectors + admin (OPPORTUNITY COST?)
• PED inelastic = cost passed to consumers
• risk of POLLUTION HAVENS + CARBON LEAKAGE - relocate production
• overallocation of permits - hard for gov to quantify how much pollution should be the cap

Question 25

What are pollution permits?

Answer 25

A government policy to tackle pollution based market failure by creating a market in the right to pollute

Question 26

How do pollution permits aim to correct market failure

Answer 26

- internalises the negative externality of pollution by turning the right to pollute into a scarce, priced resource - private costs of production rises (towards social cost) - supply shifts left and reduces output and therefore pollution to the socially acceptable level - gives all firms a clear incentive to invest in cleaner tech - abatement cheaper than buying permits = lower emissions + sell permits for more revenue

Question 27

Trend between PED and burden of tax between consumers and producers

Answer 27

The more price inelastic demand is, the larger the consumer share of the tax

Question 28

Differences between impact on consumers, producers, and the government (stakeholders) because of a subsidy vs a tax

Answer 28

Indirect tax: Consumers: pay higher prices, consume less, loss of consumer surplus Producers: receive a lower net price, sell less output, profit may fall Government: gains tax revenue, which can fund public services or correct externalities, but may cause deadweight loss Subsidy: Consumers: lower prices, more consumption, gain consumer surplus (especially for merit goods) Producers: higher revenue and output, can expand production and employment Government: incurs opportunity cost from spending; risk of inefficiency if subsidy is badly targeted