Government intervention

What are the advantages and disadvantages of introducing an indirect tax on a good with negative externalities?

Advantages:

• Internalises externality - social welfare maximised

• Raises government revenue

Disadvantages:

• Difficult to know the size of the externality - difficult to target tax

• Could be conflict between gaining government revenue and solving externalities - setting tax difficult

• Lead to black markets

• Politically unpopular

• Regressive - poor spend larger proportion of income than rich

What are the advantages and disadvantages of using subsidies on to solve positive externalities?

Advantages:

• Society reaches social optimum output - welfare maximised

• Other positive impacts - encourages small businesses, equality, encourages exports

Disadvantages:

• High opportunity cost

• Difficult to target - size of externality unknown

• Inefficient production - especially long-term

• Difficult to remove

What are maximum prices?

Legally imposed price for a good that suppliers cannot charge above. Set on goods with positive externalities

What are minimum prices?

Legally imposed price at which the price of the good cannot go below. Set on goods with negative externalities

What are the advantages/disadvantages of using max/min prices for externalities?

Advantages:

• Increase social welfare - MSB = MSC

• Ensures goods are affordable and producers get fair prices - reduce poverty

Disadvantages:

• Distortion of price signals - excess supply/demand

• Difficult for government to know where to set prices

• Black markets

What is a pollution permit?

A permit which allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits the maximum amount of pollution. Can be bought and sold

What are the advantages/disadvantages of using pollution permits for externalities?

Advantages:

• Guaranteed for pollution to fall - social welfare maximised

• Government revenue raised

• Incentivises green investment

• Encourages efficiency - cut pollution/buy permits decision for firms

Disadvantages:

• Expensive to monitor

• Raise costs for businesses - passed onto consumers

• Difficult to know how many permits to issue

What are the advantages and disadvantages of the state providing public goods for externalities?

Advantages:

• Corrects market failure - improved social welfare

• Equality

• Benefits from goods

• Efficiency through competitive tenders

Disadvantages:

• Expensive - high opportunity cost

• Market not involved - wrong combination of goods

• Government inefficiency - no incentive to cut costs

• Corruption and conflicting objectives in government

What are the advantages/disadvantages of provision of information?

Advantages:

• Helps consumers act rationally - market works properly

• Best when used alongside other policies

Disadvantages:

• Expensive - opportunity cost

• Government may not have information

• Consumers may not listen due to irrational behaviour

What are the advantages and disadvantages of regulation?

Advantages:

• Help overcome market failure

Disadvantages:

• Expensive to monitor - opportunity cost

• Less efficient than tradable permits for pollution

• Government suffers from regulatory capture

• Firms pass on costs to consumers

• Reduce competition - efficiency

What is government failure?

When government intervention in the market leads to net welfare loss and a misallocation of resources. MSC > MSB

What are the 4 forms of government failure?

• Distortion of price signals

• Unintended consequences

• Excessive administration costs

• Information gaps