Theme 1 KAA and Evaluation

Taxation to solve market failure

KAA

• Taxes can be levied on demerit goods like cigarettes or sugar

• S shifts inwards, D contracts, price increases

Evaluation

• However if the product’s demand is inelastic, government revenue will increase, but few people would have given up smoking, and therefore the market failure has not been fixed

• The tax functions as a revenue increasing tool, not a consumption decreasing tool

• The tax is not enough to close the gap between the market equilibrium and social optimum, and is an example of government failure

Government intervention as a solution

KAA

• d

Evaluation

• the EU’s Common Agriculture Policy was designed to stabilise food prices and protect farmers

• However the policy incentivised overproduction, distorted global prices and still costs taxpayers billions to pay off

• It can be suggested that the welfare loss from government intervention was greater than the welfare loss from the original market failure

• Doing nothing may be the better economic answer

a

a