1.4 Government Intervention

What are the different government interventions in the market?

• Indirect Taxation

• Subsidies

• Maximum and Minimum Prices

• Tradable pollution Permits

• State Provision of Public goods

• Provision of Information

Why might the government introduce indirect taxation?

When a good has negative externalities, the government can introduced indirect taxation to prevent market failure. This will cause a fall in supply and an increase in costs to the individual.

Advantages of Indirect Taxation

• It internalises the externalities - the market now produces at social optimum level and the social welfare is maximised.

• It raises revenue for the government wish in they can use to solve externalities in other ways such as through education. This helps to make goods become more elastic in the long run. The effect depends on what the government does with the revenue they raise.

Disadvantages of Indirect Taxation

• It is difficult to know the size of the externality so it difficult to target the tax. The effect depends on where the tax is set. The government suffers from imperfect information when setting the tax.

• If demand for a good is inelastic, then the tax will be ineffective at reducing output.

• It can lead to the creation of black markets

• They are regressive meaning the poor spend a larger propagation of their income on indirect tax than the rich do.

Why might the government introduce subsidies?

In order to solve positive externalities, the government can introduce subsidies. They also be introduced in order to fix information gaps. This will cause supply to increase and cost of production to decrease.

Advantages of Subsidies

• Society reaches the social optimum output and welfare is maximised.

• Encourages small businesses

Disadvantages of Subsidies

• The government has to spend a larger propagation amount of money which will have a high opportunity cost.

• Subsidises are difficult to target since the exact size of the externality is unknown.

• It can cause producers to become inefficient, especially if they are placed for a long time.

• Once introduced, subsidies are difficult to remove.

What is maximum prices?

A maximum price is a legally imposed price for a good that the suppliers cannot charge above. They are set on goods with positive externalities. They prevent monopolies from exploiting customers.