GOVERNMENT INTERVENTION IN MARKETS

1. What is the main purpose of government intervention in markets?

To correct market failure, improve efficiency, redistribute income, or achieve social objectives when free markets do not produce optimal outcomes.

2. What is market failure?

Market failure occurs when the allocation of resources by the free market is not efficient, leading to a net social welfare loss.

3. How can governments use indirect taxes to correct market failure?

By increasing the price of goods that cause negative externalities, reducing demand and shifting the supply curve upwards.

4. What is an ad valorem tax?

A tax calculated as a percentage of the price of a good.

5. What is a specific tax?

A fixed amount of tax per unit of a good sold, regardless of price.

6. How does an ad valorem tax affect supply and price?

It shifts the supply curve left/upwards by an increasing amount as price rises, increasing the price consumers pay and reducing quantity demanded.

7. How does a specific tax affect supply and price?

It shifts the supply curve left/upwards by a fixed amount per unit, increasing the price and reducing quantity demanded.

8. Draw the diagram for an indirect tax.

[Supply curve shifts up; price rises, quantity falls; tax revenue and deadweight loss illustrated]

9. How can subsidies correct market failure?

By lowering the cost of production, increasing supply, encouraging consumption or production of goods with positive externalities.

10. Give an example of a subsidy.

Government grants to renewable energy producers to encourage clean energy.

11. What is the effect of a subsidy on supply and equilibrium?

Supply shifts right/downwards, price falls for consumers, quantity rises, and social welfare increases.

12. Draw the diagram for a subsidy.

[Supply shifts down; lower price, higher quantity; area showing subsidy expenditure]

13. What is a maximum price (price ceiling)?

A legally set price below the equilibrium to make essential goods affordable.

14. Give an example of a maximum price.

Rent control in housing markets.

15. What is the effect of a maximum price on the market?

Leads to shortages (excess demand), possible black markets, and allocative inefficiency.

16. Draw the diagram for a maximum price.

[Horizontal line below equilibrium; ( ext{quantity demanded} > ext{quantity supplied}); shortage highlighted]

17. What is a minimum price (price floor)?

A legally set price above equilibrium to protect producers.

18. Give an example of a minimum price.

Minimum wage for workers or agricultural price supports.

19. What is the effect of a minimum price on the market?

Leads to surpluses (excess supply), potential government purchase of excess stock, and allocative inefficiency.

20. Draw the diagram for a minimum price.

[Horizontal line above equilibrium; ( ext{quantity supplied} > ext{quantity demanded}); surplus highlighted]

21. What are tradeable pollution permits?

A market-based intervention where firms buy and sell permits allowing them to emit a certain amount of pollution.

22. How do tradeable pollution permits reduce pollution?

They create a financial incentive for firms to reduce emissions, as unused permits can be sold.

23. What is state provision of public goods?

Government supplies goods that are non-excludable and non-rivalrous because the market underprovides them.

24. Give examples of public goods.

National defence, street lighting, flood defences.

25. How does government provision of information correct market failure?

By addressing asymmetric information, helping consumers and producers make better choices.

26. Give an example of provision of information.

Food labelling, public health campaigns, energy efficiency ratings.

27. What is regulation in the context of government intervention?

Rules set by the government to control or influence market behaviour, often to correct negative externalities or ensure fairness.

28. Give examples of regulation.

Health and safety laws, emission limits, advertising restrictions, minimum standards for products.

29. Why is government intervention not always successful?

Because of unintended consequences, high administrative costs, imperfect information, and potential market distortions.

30. How can diagrams help explain government intervention?

They visually show shifts in supply or demand, changes in equilibrium price and quantity, and the effects on social welfare or deadweight loss.