1.4.1 - government intervention in markets

why does government intervention happen

to combat market failure

5 ways governments can deal with an over-allocation of goods

PRIMT:

• Provision of information

• Regulation

• Indirect taxation

• Minimum prices

• Tradable pollution permits

regulation definiton

government imposes rules regarding the production, sale or use of a product

backs this up legally (prison, fines etc)

regulation examples

illegal drugs

alcohol age limit

warnings on cigarette packets

regulation strengths and weaknesses

• easy to understand

• simple to administer

• possible to achieve international agreements

• may be difficult and expensive to enforce

• firms may ignore fines if not large enough

indirect taxation definition

a tax on expenditure

placed on the producer to increase costs of production, causing supply to shift left (raises price, reduces quantity)

[see more on 1.2.9a notes]

strengths and weaknesses of indirect taxation

• easy to understand

• flexible - can be adjusted as the problem changes

• internalises the externality

• raise revenue that gov can use to further reduce externalities

• can affect consumers more than producers (inelastic goods)

• inelastic demand = consumption won’t reduce significantly

• questions about motive: to raise gov revenue or to deal with the problem to society?

tradable pollution permits definition and process

limit placed on the amount of pollution:

• corresponding number of permits are released

• permits can be bought and sold (there is a price for pollution)

• incentive: low polluters buy less or can sell spares

• over time gov reduce number of permits available (less pollution, higher price of pollution)

tradable pollution permits diagram

welfare loss reduced when pollution permits introduced

strengths and weaknesses of tradable pollution permits

• uses advantages of price mechanism (signals, incentives, rationing) to deal with problem of pollution

• will reduce total size of externality

• internalises the external cost (makes it a priv cost - polluter is paying for the pollution)

• gives message that pollution is ok

• difficult to introduce and set right number of permits

• expensive to regulate

• firms may outsource production to countries without permits

provision of information definition

gov uses advertising campaigns, education and laws to combat information failure

eg. warn ppl ab smoking = shift demand left

strengths and weaknesses of provisions of information

• is often easy to understand

• simple to administer

• ppl may ignore

• scientific knowledge may change

• may be difficult to understand

• no financial disincentives

minimum prices (aka price floor) definition

minimum price set above the equlibirum to reduce demand for demerit goods/goods with neg. externalities

results in excess supply (amount dependent on how far above equilibrium price is set)

ps. minimum wage also counts: minimum price of labour

minimum prices graph

more elastic = more excess supply (+vice versa)

not shown in photo but also possible to put minimum price on neg. externality diagram

strengths and weaknesses of minimum prices

• internalises the external cost

• guaranteed fair price for producers

• reduces demand for demerit goods

• may be expensive to regulate (gov has to buy up excess supply)

• can encourage over-production if the gov will buy excess (easy money for the producers)

• inelastic = consumers pay more for a good

• can result in black market

5 ways the gov can deal with an under-allocation

PRMSS:

• Provision of information

• Regulation

• Maximum prices

• Subsidies

• State provision

regulation in underallocation

can make certain services compulsory (eg. education)

provision of information in underallocation

inform ppl of the benefits of merit goods

shift demand right, nearer to marginal social benefits

subsidies definition

reduces costs of production to the producer, therefore inceasing supply and reducing price

encourages consumption of a good with positive externalities

[see more on 1.2.9b notes]

strengths and weaknesses of subsidies

• easy to understand

• use of the price mechanism (incentives)

• expensive for the government

• producers may become dependent on the subsidy

• opportunity cost for government

• inelastic demand = very large subsidy to increase consumption significantly

state provision definition

government directly provide a product at zero price

• funded through taxation

• either public goods or goods with positive externalities

eg. lighthouses, education

state provision diagram

gov provide smt at 0 price

so everyone who wouldn’t have been willing/able to pay equilibrium price are now using it

so excess demand

strengths and weaknesses of state provision

• fair - access to all instead of those who can afford

• only way to provide public goods

• expensive for the government

• opportunity cost for the government

• excess demand = rationing, queuing, etc

• state monopoly can lead to inefficiency (no incentives bc no price)

maximum prices (aka price cap, price ceiling) definition

set below the equilibrium to set limits on the returns that producers make OR to help consumers afford necessities eg. bread, housing

results in excess demand (how much depends on how far below equilibrium min price is set)

maximum prices graph

excess demand = waiting lists, queues, gov may have to provide (eg. social housing)

strengths and weaknesses of maximum prices

• will increase consumption of goods with priv/social benefits

• will help solve inequality by ensuring everyone has necessities (eg. housing, food)

• excess demand = queues/waiting lists

• expensive - state may have to devise systems to allocate based on greatest need

• black market may develop