Notesale: Turn your study into money

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1
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g
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➔ If there is an underconsumption of merit goods
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➔ To meet people’s basic needs (especially if they’re on low incomes)
...

● Direct taxes are paid directly to the government by the taxpayer (e
...
income
tax) whilst indirect taxes are taxes levied on the expenditure of goods or
services (e
...
VAT)
...
g
...

● The burden of direct taxes cannot be passed on, whilst producers can pass
on the cost of indirect taxes to the consumer (in whole or in part - depending
on PED/PES)
...
5p)
...

● Subsidy = a grant provided by the government to encourage the production
and consumption of a particular good or service
...

Specific tax diagram

Ad-valorem tax diagram

Indirect taxes - advantages
➔ The external costs are internalised by making both the producer and
consumer pay tax
...

➔ Tax funds raised by the government can be used to clean up the environment
or to compensate the victims of pollution
...

➔ Level of pollution should fall as output is reduced and the price increased social optimum can be reached
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➔ Increase the costs of production for firms, so they are less competitive
...

➔ Firms may relocate to countries with less stringent taxes on production
...


➔ Unintended consequences might occur - e
...
tobacco and alcohol smuggling
and illegal markets
...

Subsidies
● Subsidies = grants given by the government to encourage the production and
consumption of a particular good or service
...
Consumers end up paying the socially
efficient price which includes the external benefit
...
In the long term, subsidies for a good will
help change preferences
...

➔ Reduction in external costs - external benefits are internalised
...
g
...

Subsidies - disadvantages
➔ The cost will have to be met through taxation
...
g
...
Though the most efficient way to raise
revenue for subsidising positive externalities would be to tax goods with
negative externalities, e
...
tax cars driving in city centres (congestion charge)
and use the money to pay for public transport
...
Therefore the
government may have poor information about the service and how much to

subsidise
...

➔ Opportunity costs for the government
...

➔ The effect depends on the elasticity of demand
...

● Short term measure
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● Issues: buffer stocks do not guard against volatile incomes, only effective if
goods can be stored, moral issues with storing food and cost of storage
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Income stabilisation schemes
● Aims to ensure that farm incomes remain fairly constant
...

● Costs: looking at historical data to calculate income so farmers may respond
to inaccurate market signals and the market becomes distorted (imperfect
knowledge of the market)
...

Tradable pollution permits
● Tradable pollution permits = pollution permits that can be bought or sold in
a market
...
g
...

● Part of EU environmental policy - EU Emissions Trading System (ETS)
...
g
...

● Market-based mechanism to incentivise the reduction of greenhouse gas
emissions
...

● The system “caps” the amount of carbon emissions for the year and the
permits are tradable
...


● Whilst most of the permits are free, national governments are allowed to
retain up to 10% of permits and offer them up for sale
...

● Began in 2005 and the 3rd phase will end in 2020
...

● The EU annually cuts the number of permits available
...

● Advantages: the price mechanism is used to internalise the external costs of
pollution, governments can use the revenue from selling permits to clean up
the environment or compensate victims and firms have an incentive to invest
in cleaner technology
...

Regulation and deregulation
● Regulation = government rules and laws that can control the behaviour of
producers or consumers in a market
...
g
...

● Benefits of deregulation: government stops intervening with the free market
so allocation of resources should improve, less bureaucracy so efficiency
should improve
...

● Benefits of regulation: regulation can correct market failures which result
from externalities, can be used to protect the environment, prevents
monopolies from exploiting consumers, legislation means that firms can be
punished for anti-competitive behaviour
...
g
...
g
...

● The government pays for public services through tax revenues
...

● Disadvantages: value judgements must be made about what the government
should and should not provide, services may be less efficient as there is little
incentive, opportunity cost, if there’s asymmetric information then there’s a
risk of government failure
...
g
...


Maximum price schemes
● A maximum price is a ceiling price set by the government on a good or
service, above which it cannot rise
...

● There are price caps on
electricity and gas, as well as on
selected rail fares and postal services
...

● This is because of a
contraction in supply but an expansion
in demand (because goods get cheaper
so more people can afford them, but
there is less incentive for profit-maximising firms to supply them)
...

Advantages of max
...
prices

Reduces exploitation of customers,
especially where there is a lack of
competition
...
g
...
Also it’s difficult
for the govt to enforce schemes shadow markets* may occur (e
...
ticket
touts)
...
g
...


It can reduce the supply of key products
- less incentive for producers
...

less investment
...

(e
...
first-come, first-served basis or
sellers’ preference which are unfair)
...

Minimum price schemes
● A minimum price is a floor price set
by the government on a good or
service, below which it cannot fall
...

● E
...
minimum wage to prevent
exploitation of workers, minimum
prices on goods with high external
costs (e
...
sugar and alcohol)
...
When there is excess supply, it is bought up by a government
agency (at the guaranteed minimum price) and stockpiled
...

The minimum price must be set above the equilibrium to have an impact
...


● Guaranteed minimum price = where the surplus output created is purchased
by a government agency at the minimum price
...

Advantages of min
...
prices

They can reduce the consumption of
harmful goods like alcohol
...
g
...


They encourage consumers to switch to
healthier alternatives
...


They reduce fluctuations in food prices
so it's easier for consumers to budget
...


Guaranteed minimum prices can
Opportunity cost of the government
stabilise and increase producer incomes spending money on buying up
leading to more investment and
surpluses
...

Food surpluses can be used as
international aid
...
Some
may have to be destroyed (perishable)
...


Food surpluses may be sold overseas
at very low prices, which could undercut
local farmers and reduce their incomes
...


Government failure
● Government failure is when the government intervenes to correct a market
failure, but the results are a more inefficient allocation of resources and there
is a net welfare loss
...
g
...

● Law of unintended consequences!
● Examples: a tax on rubbish leads to fly tipping, the UK smoking ban led to a
rise in sales of outdoor patio heaters, the housing shortage (which may also
cause labour market failure due to the geographical immobility of labour)
...


● The National Minimum Wage could lead to government failure if instead of
raising living standards, people become unemployed
...

● Regulatory capture = a form of government failure, happens when a
government agency operates in favour of producers rather than consumers
...

One example of the law of unintended consequences is the introduction of the buffer
stock scheme CAP (Common Agricultural Policy) in the EU
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On top of this, targets for treating patients on the NHS has led to a
reduction in the quality of care
...

● Net welfare loss = an overall loss of economic welfare compared to the
starting position
...

● Administration costs = the costs which arise in the formulation, monitoring
and enforcing of government measures to correct market failure
...
is actually spent on organisational
administration rather than putting the money into medical care
...

● Government information gaps = the government has insufficient information
to make rational economic decisions
...

Cost and benefit forecasts of investment are often wrong and so the government
invests in a system where the costs are higher than the benefits, so there is welfare
loss
...




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