1.4 Government Intervention Flashcards

Flashcards covering government intervention in markets, including indirect taxation, subsidies, price controls, pollution permits, public goods, information provision, regulation, and government failure.

Indirect taxation

When the good has a negative externality, the government can introduce this to prevent market failure. It causes a fall in supply and increases costs to the individual.

Advantages and disadvantages of Indirect Taxation

It internalizes the externality, raises government revenue, but can be difficult to target and may lead to a black market.

Subsidies

In order to solve positive externalities, the government can introduce these, shifting the supply curve to the right and lowering the cost of production.

Advantages and disadvantages of Subsidies

Society reaches the social optimum output, but it can be expensive, difficult to target, and cause producers to become inefficient.

Maximum price

A legally imposed price for a good that suppliers cannot charge above; must be set below the current price equilibrium to have an effect.

Minimum price

A legally imposed price at which the price of the good cannot go below; must be above the current price equilibrium to have an effect.

Advantages and disadvantages of Maximum and Minimum Prices

They can allow for some consideration of externalities and help to increase social welfare, but there is a distortion of price signals causing excess supply/demand.

Tradable pollution permits

Allows the owner to pollute up to a specific amount, with the government controlling the number of permits to limit pollution.

Advantages and disadvantages of Tradable Pollution Permits

Guaranteed pollution reduction, raises government revenue, and encourages green technology, but can be expensive to monitor and police.

State provision of public goods

Non-excludable and non-rivalrous goods that will be under-provided by the free market, leading to market failure; provided directly by the government through taxation.

Advantages and disadvantages of State Provision of Public Goods

Corrects market failure, brings about equality, and improves economic growth, but is expensive and may produce the wrong combination of goods.

Provision of Information

Provided by the government when there is asymmetric information to allow people to make informed decisions.

Advantages and disadvantages of Provision of Information

Helps consumers to act rationally, but can be expensive and consumers may not listen to the information provided.

Regulation

Governments impose these and laws to ensure levels are set where MSB=MSC or to ensure companies provide full information on products.

Advantages and disadvantages of Regulation

Ensures consideration of externalities and prevents exploitation of consumers, but may be expensive to monitor and doesn’t account for different company costs.

Government failure

When government intervention in the market leads to net welfare loss and a misallocation of resources.

Causes of government failure

Distortion of price signals, unintended consequences, excessive administration costs, and information gaps.

Distortion of price signals

Government intervention changes price signals, distorting the free market mechanism.

Unintended consequences

Interventions cause effects which the government did not intend to happen.

Excessive administration costs

A lot of money allocated by the government is used up on basic administration costs.

Information gaps

Government decisions are based on limited data, leading to incorrect cost and benefit forecasts.

Ad Valorem Tax

Tax levied as a percentage of the price of a good or service (e.g., VAT).

Specific Tax

Tax levied as a fixed amount per unit of a good or service (e.g., excise duty on cigarettes).

Market Intervention Diagram

Diagram showing the effects of government intervention, such as taxes or subsidies, on market equilibrium.

Trade Pollution Permits

Permits allowing firms to pollute up to a certain level; can be traded between firms.

Public Goods

Goods that are non-excludable and non-rivalrous, often provided by the government because the free market under-provides them.

Provision of Information

Action by the government to ensure consumers and producers have sufficient information to make informed economic decisions.

Regulation

Rules or laws imposed by the government to control market behavior, often aimed at correcting market failures.

Government Failure

When government intervention leads to a less efficient allocation of resources and a decline in economic welfare.

Asymmetric Information

Situation where one party in an economic transaction has more information than the other, leading to potential market inefficiencies.

Government failure

When government intervention leads to a less efficient allocation of resources and a decline in economic welfare.

Causes of government failure

Distortion of price signals, unintended consequences, excessive administration costs, and information gaps.

Distortion of price signals

Government intervention changes price signals, distorting the free market mechanism.

Unintended consequences

Interventions cause effects which the government did not intend to happen.

Excessive administration costs

A lot of money allocated by the government is used up on basic administration costs.

Information gaps

Government decisions are based on limited data, leading to incorrect cost and benefit forecasts.

Examples of government failure

Occurs in various markets, including healthcare, education, and environmental regulation, leading to inefficiencies, inequities, and unintended consequences.

Government failure in healthcare

Can result from price controls, subsidies, or regulations that distort market signals, leading to shortages, surpluses, or reduced quality of care.

Government failure in education

May arise from inefficient allocation of resources, bureaucratic inefficiencies, or policies that stifle competition and innovation, resulting in poor educational outcomes.

Government failure in environmental regulation

Can occur when regulations are poorly designed, weakly enforced, or based on incomplete information, leading to ineffective pollution control and resource management.

Principal-agent problem in government

Arises when government agents (e.g., bureaucrats) pursue their own interests rather than the interests of the public, leading to inefficient or corrupt behavior.

Rent-seeking behavior

Occurs when individuals or firms seek to gain economic advantages through political manipulation rather than through productive activities, leading to resource misallocation and reduced competition.

Regulatory capture

Happens when regulatory agencies become dominated by the industries they are supposed to regulate, leading to regulations that favor the interests of the regulated firms rather than the public interest.

Pork barrel spending

Refers to government projects or appropriations that benefit narrow interests or specific geographic areas, often at the expense of broader public welfare.

Short-termism in government

Describes the tendency of politicians to focus on short-term gains rather than long-term consequences, leading to unsustainable policies and neglect of important long-term challenges.

The difference between Government failure vs Market Failure

Government failure occurs when intervention in the market leads to a less efficient allocation of resources, while market failure is when the free market fails to allocate resources