Government intervention in markets 1.4.1

What is a fiscal policy?

The use of government spending and/ or taxation can be used o alter the level of demand for different products and the pattern of demand

How can indirect taxes be used as an intervention?

Can be used to raise the price of products with negative externalities designed to increase the opportunity cost of consumption and thereby shift the market equilibrium towards a socially optimum level

How are subsidies to consumers used as an intervention?

They lower the price of goods with positive externalities which will boost consumption and output of products. They cause an increase in market supply and leads to a lower equilibrium price

What is a consequence of the market failure factor immobility and give an example of government intervention?

• Consequence: Structural unemployment

• Example: State investment in education and training

What is a consequence of the market failure public goods and give an example of government intervention?

• consequence: Failure of markets to provide pure public goods, free rider problem

• Example: Government funded public goods for collective consumption

What is a consequence of the market failure negative externalities and demerit goods and give an example of government intervention?

• Consequence: Over consumption of products that are ‘bad’ for us/ society

• Example: Information campaigns, minimum age for consumption, indirect taxes

What is a consequence of the market failure positive externalities, and merit goods and give an example of government intervention?

• Consequence: Under consumption of products that are ‘good’ for us/ society

• Example: Subsidies, better information on private benefits

What is a consequence of the market failure information gaps and give an example of government intervention?

• Consequence: Damaging consequences for consumers from poor choices

• Example: Statutory information/ labelling

What is a consequence of the market failure high relative poverty and give an example of government intervention?

• Consequence: Low income families suffer social exclusion, negative externalities

• Example: Taxation and welfare to redistribute income and wealth, invest in education and retraining

What is a consequence of the market failure monopoly power in a market and give an example of government intervention?

• Consequence: High prices for consumers cause loss of allocative efficiency

• Example: Competition policy, measures to encourage new firms into a market

How is tax relief used a a fiscal policy intervention?

The government may offer financial assistance such as tax credits for business investment in research and development or a reduction in corporation tac designed to promote new capital investment and extra employment

How are changes to taxation and welfare payments used as a fiscal policy intervention?

Can be used to influence the overall distribution of income and wealth, for example higher direct tax rates on rich households or an increase in the value of welfare benefits of the poor to make the tax and benefit system more progressive.

What is the aim of an indirect tax?

To internalise a negative externality, make those directly involved in the market transaction bear the cost of the externality.

What are some of the reasons as to why implementing indirect taxes is difficult?

• Setting the right tax rate- if the monetary value of a negative externality is hard to measure

• Cost of collection

• Price inelastic demand- for example if high fuel prices have little effect on demand for petrol, will a similar thing happen with sugar tax

• Redistribution effects- indirect taxes are regressive and affect low-income households most

• Increased costs- higher indirect taxes may cause inflation affecting customers who did not pollute and international competitiveness if taxes are higher in one country compared to another

What questions should be asked when evaluating government subsidies?

• Are they effective in meeting their aims?

• Will a subsidy affect productivity/ efficiency?

• How much does a subsidy cost and who benefits?

• Does the subsidy help to correct one or more market failure(s)?

What should you check when judging the effects of intervention?

• Efficiency of the policy

• Effectiveness of the policy

• Equity effects of the intervention

• Sustainability of the policy

• Does the policy need to be used alongside something else

How does maximum prices work?

Legally-imposed maximum price (or price ceiling) in a market that suppliers cannot exceed.

What are the requirements for a maximum price to be effective?

Has to be set below the existing free market equilibrium price

How are secondary markets sometimes developed as a result of maximum prices?

Often lead to secondary (unofficial) markets developing because of a scarcity of supply means that some consumers are willing and able to pay above the regulated price.