1.4.1 Government Intervention

Subsidies and indirect taxes done

Market failure = When the price mechanism leads to an inefficient allocation of goods and services and a dead weight loss of economic welfare

Examples of market failure:

• Neg and Pos externalities - self interest as firms are profit maximisers and consumers are utility miximisers

• Under provision of public goods - free rider

• De-merit goods/ merit goods - information failure which may make consumers make irrational decisions when purchasing

• Information failure

• Monopolies - one dominant seller and high barriers to entry

• Inability of the factors to move

Assessing Indirect taxes

Effectiveness:

• Depends on the PED

• Problems associated with setting tax at the right level yo achieve aims

• Unintended consequences - i.e. inequality

Does it raise revenue ? Does it generate sufficient revenue especially in elastic demand

How is the tax revenue used ? Is it used for a specific purpose i.e. sugar and sport in primary schools.

What are the effects on competitiveness ? Will businesses cut back on jobs or investment ?

Consequences for equity/ redistribution on wealth ? Who are the winners/ losers ? Is it regressive i.e. VAT

Assessing Subsidies

Effectiveness:

• Will they achieve their desired stimulus / incentivise an increase in demand i.e. if PED is low there may need another incentive

• Will a subsidy effect productivity and efficiency ? Subsidies for research and investment will bring about positive spillovers but cane some firms become too dependant on govt. subsidies

• How much does the subsidy cost ? Who is pay? Is it part self financing i.e. creates more jobs therefore generates more taxation or will it create an added burden onto the tax payer.

• Does it really correct market failure ???

Minimum Prices

Minimum price + = a legally imposed price floor mostly associated with minimum wages

Or Minimum price per unit i.e. Scotland and alcohol at 50p per unit and minimum care price

• Always consider PED for labour ect. to build analysis - when considering the extent of contraction of demand

Aim: not to contract supply rather decrease/shift demand

Disadvantages:

• If demand has a high PED ( elastic ) this could hit production, profits and jobs in the drinks industry

• Impact on high consumption groups may be regressive in nature

• Doesn’t actually bring in any tax revenue for the govt. for reinvestment

• Causes excess supply in the market - market distortions - over production

• These surpluses may require extra govt. intervention such as storage and export subsidies to prevent waste

• Risks of waste dumping and trade wars - which may occur if nations are accused of waste dumping to get rid of extra stirage

• Minimum price may discourage innovation and efficiency esp in agri market

What are the alternatives:

• Indirect taxes

• Behavioural nudges i.e. provision of education to change demand - lessen imperfect info

• Raise minimum drinking age to 21 - regulation

Minimum Prices for Farmers:

• So, this is usually a positive as farmers are essentially price takers

• So minimum prices in the agri industry is designed to stabalise farmers incomes and ensure they receive at least a certain amount for their produce i.e. corn and wheat

• By setting a floor price the govt. ensures farmers are receiving a minimum level of income to cover all costs of production to maintain livelihood and protect smaller farmers

  

Maximum Prices

Maximum prices act as a price ceiling of which suppliers cannot exceed i.e. Rent control in Oregon and energy price caps

I.e. Paydays loans at 0.8% and gambling

Evaluating ( i.e. Rent )

• Lead to an extension in Demand from Q1 - Q3 as consumer surplus increases and more people can now afford

• However, in turn this results in a shortage of supply due to the now excess demand in a market - distorting the price mechanisms

• If some people are willing to pay higher prices this risks black market transactions which results in an even higher price

Benefits

• Rent controls are needed to reduce excess profits of landlords from those in need

• High rents impede on the geographical mobility of labour which may in turn have a direct affect on unemployment

• High rents reduce peoples disposable income which will cause a decrease in AD as well as an increased reliance on the benefits system - taxes

Drawbacks:

• May result in landlords withdrawing from investment resulting in a diminished supply of private sector rented housing

• Landlords may cut back on large levels of maintenance spending reducing the quality of rented housing and increase risks for tenants - external costs - i.e. dampness

• Some landlords may switch markets from rented property to houses to buy which will ultimately increase housing prices

In evaluation in the exam always consider alternatives for example:

• Govt could consider tax relief when building affordable houses on brownfield sites

• Increased spending on social housing

• Always discuss PED

• May benefit from better education - to reduce imperfect knowledge

Contextual knowledge: Rent in London is over double that of Newcastle - also 3x

Trade Pollution Permits