1.5.2 government intervention and failure

Why do governments intervene in markets?

To correct market failure and provide goods/services underprovided by the free market, e.g., healthcare and education

What is regulation and legislation?

Laws to ban or mandate certain behaviours, e.g., minimum school leaving age, compulsory recycling schemes

Advantages of regulation

Positive externalities, disincentive for rule-breaking through fines

Disadvantages of regulation

High administrative costs, harder for firms, potential black markets

What is an indirect tax?

A tax on expenditure that increases production costs, reduces supply, increases price, and contracts demand

Purpose of indirect tax

Discourage demerit goods, reduce negative externalities

Types of indirect taxes

Ad valorem (percentage, e.g., VAT) and specific (set per unit, e.g., fuel duty)

What is tax incidence?

How the burden of a tax is shared between consumers and producers

How does price elasticity affect tax incidence?

More inelastic demand = consumers bear more of the tax burden; more elastic = producers bear more

What is a subsidy?

Payment from the government to producers to lower costs and encourage production/consumption of merit goods

Purpose of subsidy

Internalise external benefits; increase output, reduce price

Advantages of subsidies

Encourage merit goods, positive externalities, cheaper for consumers, higher supply

Disadvantages of subsidies

Opportunity cost to government, potential inefficiency, government failure

Causes of government failure:

Distortion of price signals

Subsidies can misallocate resources, e.g., supporting failing industries

Unintended consequences

Consumers/producers act in unexpected ways, undermining policy goals

Excessive administrative costs

Policy may cost more than the social benefits

Information gaps

Policies made without perfect information can fail or require costly analysis

Government failure in agriculture:

Example: buffer stock system to reduce price volatility

Advantages

Stable farmer incomes, benefits rural areas, protects consumers from price spikes

Disadvantages

Expensive, overproduction, storage difficulties, environmental impact

Government failure in housing:

Market failure: housing shortage and inefficient allocation

Effects

Impacts labour mobility, wealth effect, and consumer spending

Causes

Information asymmetry, short-term price volatility

Intervention: government can influence housing supply and affordability

Government failure in labour markets:

Causes of market failure

Immobility, skills gaps, discrimination

Interventions

National Minimum Wage (NMW), Equal Pay Act, minimum school leaving age

Risks

NMW could theoretically increase unemployment, but evidence in the UK shows no significant effect