1.4- Government Intervention

What are administrative costs?

costs to the government of implementing, enforcing + monitoring a policy in a market

problems arising from indirect taxes?

if price is inelastic → tax less effective, consumers still purchase good

setting tax at right level → overtax leads to shadow markets

regressive → more inequality

problems arising from subsidies?

setting subsidy at right level → over subsidy = costly

how firms use the subsidy

firms become dependant on subsidies

if demand is inelastic → less effective

Types of government intervention

1. indirect taxes

2. subsidies

3. max price / min price

4. state provision

5. provision of information

6. regulation

define regulation

a rule / law enacted by the government and followed by economic agents to encourage a change in behaviour

problems with regulation

costly to enforce → policing required

setting at right level, if too strict firms close down → unepmloyment

rise in shadow markets→ consumers look for alternative supply

if regulation to lax, firms won’t change

what is a tradeable pollution permit

gives a firm the right to emit a given quantity of waste or pollution into the environment

internalises the externality

disadvantages of tradeable pollution permits

enforcement is costly

cap not set at right level. Too low = companies happy to pollute

firms might shut down or move to countries with lax rules

need for international cooperation as pollution is a global issue

what is state provision of goods

the direct provision of goods/ services by the government free at the point of consumption

(not provided by the private sector due to free ride problem)

(funded by taxation)

ADV of state provision

• corrects market failure

• improves equity and access- everyone gets access to service regardless of income

• promotes positive externalities-→ healthier, educated population

DIS of state provision

high opportunity cost- paid from taxation

potential inefficiency 

overconsumption- people may over use free services

drawbacks of min price

if demand is inelastic → quantity demanded won’t fall enough

regressive → impacts poor more than rich → increasing inequality

rise in shadow markets as individuals find alternative supply

cap not set at right level → if too low or high demand won’t reach socially optimum level

what is minimum price used for

to discourage consumption of goods with negative externalities

set above market price

what are maximum prices used for?

encourages consumption of goods with positive externalities

DIS of max prices

shortages

shadow markets → dangerous 

high opportunity cost

setting price cap at right level, too low → excess demand

What is the free rider problem?

Occurs when people benefit from a good or service without paying for it because it is non - excludable

What is a guaranteed minimum price?

a price floor

what is a maximum price?

price ceiling

encourages consumption of goods with positive externalities

set below the market price

what is an indirect tax

a tax imposed on expenditure on goods/services and collected by government from producers but often passed down to consumers through higher prices

where is producer and consumer incidence on a SUBSIDY diagram?

producer incidence is the HIGHER price section

consumer incidence is the LOWER price section

where is producer and consumer incidence on a TAX diagram?

consumer incidence is the HIGHER price section

producer incidence is the LOWER price section

What is government failure?

When government intervention leads to a worse allocation of resources than if the market had been left alone.

leads to a net welfare loss

What is a command economy?

an economic system where the government makes all the major economic decisions