Notesale: Turn your study into money

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Government intervention
Why do governments intervene in markets?
➔ If there is an overconsumption of demerit goods (e
...
due to a lack of
information)
...

➔ Irrationality
...

● Tax ​= a compulsory financial contribution to state revenue
...
g
...
g
...

● Indirect taxes occur when goods have significant external costs - e
...

cigarettes, alcohol and petrol
...

● 2 types of indirect tax - ​ad valorem tax ​(which is taken as a percentage of the
value of a product, like VAT = 20%) and ​specific tax ​(a fixed rate per unit, like
the tax on a pint of beer is 41
...

● Deadweight loss ​= the loss of welfare to society because taxes are
introduced
...

● Incidence of tax ​= the distribution of the tax paid between consumers and
producers
...

➔ They work with market forces so there is still choice over production and
consumption (unlike some regulations/legislation)
...

➔ Convenient - paid in small amounts and regularly rather than one lump sum
...

Indirect taxes - disadvantages
➔ Difficult to quantify external costs and then place a monetary value on them
...

➔ Widespread use may be inflationary
...

➔ Tax revenue raised may not be used to compensate victims/clean up the
environment
...
g
...

➔ Burden of indirect taxes may fall on low-income groups
...

● Diagram:

Subsidies - advantages
➔ Enables greater social efficiency
...

➔ If you subsidise public transport, it will encourage people to drive less, and
reduce their negative externalities
...
It will encourage firms to develop more products
with positive externalities
...

➔ Potential increase in employment within subsidised industries, e
...
farming
and the EU CAP
...
Some taxation, e
...
income tax,
may reduce incentives to work
...
g
...

➔ Difficult to estimate the extent of the positive externality
...
Difficult to quantify external benefits and place a monetary value on
them
...

➔ There is a danger that government subsidies may encourage firms to be
inefficient and they come to rely on subsidy rather than improve efficiency
...

Buffer stocks
● Influences market supply through holding or releasing stocks to stabilise
prices or incomes
...

● Used in agriculture and other commodities where supply can be volatile
...

Issues with long-term sustainability and indirect effects on LIDCs
...

● Benefits: ​good because farmers are unlikely to invest if they have an
uncertain future, encouraging production of goods
...
Overproduction if incomes are guaranteed
(surplus)
...

● Set up to try and limit greenhouse gas emissions by major polluters in the EU
- e
...
power generators, steel, paper, cement and ceramics industries
...

● “Cap and trade” system - each year, the European Commission allocates a
set amount of CO2 permits to national governments, which then divide up the
allowances among the firms in the scheme
...

● ETS also allows firms to invest in schemes outside the EU that offset their
own carbon emissions
...

● 1 allowance, or “carbon credit” = 1 tonne of CO2 (for example)
...


●
●
●
●

Long-term goal is the decarbonisation of the EU economy
...

Demand for carbon credits decreases during recessions
...

● Disadvantages: ​the EU may issue too many/too few permits due to
information gaps, expensive to implement schemes, market for permits is still
subject to failure, firms may pass the cost of purchasing permits onto
consumers leading to higher prices, the price of pollution permits fluctuates so
firms don’t want to invest in new technology due to uncertainty and the EU is
just one part of the world - China is the world’s largest polluter
...
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)
...

May be enforced through government
legislation
...
g
...
g
...

● Used in agriculture - EU farmers are guaranteed a minimum price for many
commodities
...

● There will be excess supply due to a contraction in demand (because fewer
people can afford to buy the product) but an expansion in supply (because
there's more of an incentive for profit-maximising firms to supply the goods)
...

● Minimum prices can be used in monopsony markets
...
prices

Disadvantages of min
...


Unintended consequences may occur
(e
...
govt intervention distorts the
operation of the price mechanism =
excess supply and inefficient allocation
of resources)
...


Disproportionately affect consumers on
low incomes
...


Demand for goods like sugar and
alcohol are price inelastic, so minimum
prices may not be effective
...

employment
...


Storage costs for food surpluses
...


A national minimum wage reduces
exploitation of workers whilst providing
an incentive to work
...

Less incentive for farmers to try and
increase their efficiency - overeliant
...

● Causes of government failure: government can cause the distortion of price
signals, unintended consequences (e
...
smuggling), political self-interest,
excessive administrative costs and information gaps
...

● Buffer stocks have traditionally been an example of government failure
...
However, there has
been no evidence of this in the UK

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