Government Intervention
- Created by: Clodagh
- Created on: 27-04-14 08:55
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- Government Intervention
- Why?
- Governments may intervene in the operation of the market mechanism if there is a market failure or inequality in the distribution of income/wealth
- The government intervenes in order to try to improve economic welfare
- State Provision of a Good or Service
- If there is complete market failure (a missing market), a government may decide to provide that good or service
- For merit goods or in markets with significant positive externalities, government may choose state provision as the best means to guarantee the right level of production
- Indirect Taxation
- Indirect taxes are taxes on a good or service (VAT)
- This method is usually used for demerit goods or goods with externalities
- Indirect taxes are popular with governments because they can improve economic welfare and also bring in extra revenue
- VAT is the main indirect tax in the UK
- Specific taxes are used for many demerit goods. This moves the supply curve parallel to the original line: there is no increase in gradient unlike VAT
- Subsidies
- A subsidy involves government giving producers a sum of money for each unit produced
- This lowers the costs of supply
- Subsidies are iseal for merit goods or goods that provide positive externalities in their consumption or production
- If demand is price inelastic, subsidies are very effective at reducing price
- If demand is price elastic, subsidies are very effective at increasing consumption
- A subsidy involves government giving producers a sum of money for each unit produced
- Price Controls
- This method usually takes the form of a guaranteed minimum price
- Government will pay this price if the market price is too low, to encourage suppliers to produce vital products
- These are often used in agriculture
- This method usually takes the form of a guaranteed minimum price
- Buffer Stocks
- Where minimum prices are used, government might accumulate stocks of agricultural products
- If the product can be preserved, government can use these buffer stocks to increase supply when a poor harvest occurs
- This can prevent shortages and high prices when supply is scarce
- If the product can be preserved, government can use these buffer stocks to increase supply when a poor harvest occurs
- In times of shortage, government uses up buffer stock; in times of good harvests government builds up buffer stock
- Where minimum prices are used, government might accumulate stocks of agricultural products
- Pollution Permits
- Pollution is a common negative externality
- To limit negative externalities, governments often license an industry, by giving permits to pollute to individual firms such that the total level of pollution is acceptable
- Some firms may find it easier/cheaper to limit their pollution below their target and sell their permits to other firms
- To limit negative externalities, governments often license an industry, by giving permits to pollute to individual firms such that the total level of pollution is acceptable
- They can be effective in reducing overall costs of pollution control, but tend to be less effective at reducing the overall level of production, unless permits are severely restricted
- Pollution is a common negative externality
- Regulation
- This is where government intervenes through legislation, such as pollution limits, or other direct controls
- Government may ban products such as drugs
- Where government's aim is merely to change the level of consumption or production
- With goods such as alcohol, regulations can be ineffective
- This is where government intervenes through legislation, such as pollution limits, or other direct controls
- Government Failure
- Government intervention attempts to improve the allocation of resources. Government failure occurs where intervention leads to a misallocation of resources or a reduction in economic welfare
- Inadequate Information
- In the past government encouraged high consumption of dairy products as medical information suggested it was healthy
- This advice has been amended as new information has been acquired
- In the past government encouraged high consumption of dairy products as medical information suggested it was healthy
- Conflicting Objectives
- The market mechanism is considered by some people to be the best means of maximising output
- However, it is also recognised as a contributor to inequality
- Government therefore faces conflict in achieving higher output and greater equality
- However, it is also recognised as a contributor to inequality
- The market mechanism is considered by some people to be the best means of maximising output
- Administrative Costs
- Where government intervenes, administration of the process is needed
- If government intervention provides welfare benefits, but to a lesser extent than the administrative costs, then the intervention has not been worthwhile
- Where government intervenes, administration of the process is needed
- Why?
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