Government intervention in the market

market failure

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  • Government intervention in the market
    • Market failure
      • Definitions
        • Markets failing inequitably
          • Occurs when there are highly unequal distributions of income and wealth
          • It occurs when the signalling incentive or allocative function breaks down
        • Markets failing inefficiently
          • Monoplies and other firms of imperfect competition provide examples of inefficient market failure
          • It occurs when the wrong quantity is produced in a market when there are no economies of scale so the wrong price is charged
          • Too little is produced and sold at too high a price making the market allocatively and productively inefficient
        • Missing markets - occur when the incentive function of prices completely breaks down and a market fails to come into existence or disappears completely.
        • Partial market failure - when the market functions but produces the wrong quantity of a product of at the wrong price.
        • Complete market failure is when the market doesn't supply products at all.
      • The price mechanism
        • This describes the means by which decisions taken by consumers and business interact to determine the allocation of scarce resources it has three main functions
        • Incentive function - The information signalled by relative prices creates incentives for people to alter their economic behaviour
        • Th signalling function - Prices provide information that allows the traders in the market to plan and coordinate their eocnomic activity so higher demand signals to producers to increase production. Higher supply and lower prices signals to consumers that their income has increased.
        • The rationing function - prices and income ration the way people spend their money as prices ration scarce resources when demand is greater than supply
      • Types of good
        • Private goods
          • Goods that are excludable and rival e.g. shampoo
        • Public goods
          • Goods that are non excludable and non rival. They can lead to market failure
        • Merit goods
          • Goods and services that the government feels that left to the free market people will under consume
          • e.g. health service, education. It genereates positive externalities
        • Demerit goods
          • Goods thought to be bad for you e.g. alcohol and cigarettes
          • Consuming these godds leads to negative externalities
          • Consumers are sometimes unaware of the negative externalities that these goods create due to imperfect information
        • Public bads
          • A bad for which the producers free ride dumping the bad on third parties
        • Quasi public goods
          • Goods that are essentially public goods but do not fully exhibit the features of public goods.
      • Externalities
        • Negative externalities
          • This occurs when the production and or consumption of a good imposes external costs on third parties outside the makret
        • Positive externalities
          • These occur when the production and or onsumption of a good creates external benefits that increases social welfare
          • Where positive externalities occur the good may be under consumed or under provided as the free market fails to value them correctly
        • Private benefit maximisation occurs when MPB = MPC
        • Social benefit maximisaiton occurs when MSC = MSB
        • MSB= MPB +MEB
        • msc = mpc+mec
        • There must be no externalities for allocative efficiency to occur because when negative externaleties occur MSC>MPC but for efficiency to occur P must = MC this is becaus eprofit maximising firms only take into account private costs and benefits meaning the wrong price is charged causing a misallocation of resources
    • Poverty, equity and equality
      • Equity
        • Means fairness of justice
        • It is a normative statement
        • Horizontal equity
          • Means we give the same treatment to people in an identical situation so income tax is the same for both therefore reducing discrimintation
        • Vertical equity
          • Means people with higher incomes should pay more which can lead to the redistribution of income and wealth due to progressive taxes
      • Equality
        • Occurs when people are equal and can be achieved by things such as reducing differentials
        • It is a positive statement as it can be measured. Increasing the amount of money before you need to be taxed increases equality
      • Types of poverty
        • Absolute poverty
          • This occurs when income is below a particular level. It means the same standard is measure across different locations and times. This makes comparison easier. But it doesn't account for the different levels of income required in different placees
          • When all incomes increase absolute poverty falls where as relative poverty only falls if low incomes grow at a faster rate than average incomes
        • Relative poverty
          • This occurs when income is below a specified proportion of average income. It works by comparing families to others in the population
          • In the UK relative poverty is more of an issue because it has a high income developed economy where welfare benefits provide a minimum income and safety net for the poor.
      • Causes of Poverty
        • Old age
          • Most people purely rely on state pension and therefore don't have a private pension
        • Unemployment
          • Increase in unemployment increases poverty as benefits are lower than average earnings
        • Low wages
          • Income support is an extra benefit paid to people on low incomes, some unskilled workers get paid low wages that can lead to poverty
        • Imperfect information
          • People dont know about the benefits they can recieve
        • Regressive taxes
          • These make the poor poorer
        • Sickness and disability
      • How it is measured
        • There is no official measure of poverty but the Joseph Rowntree foundation define household poverty as being when a households disposable income is less than 60% of the UK median
        • Poverty Audit - An assesment of the governments performance in eradicating poverty
        • The poverty trap - This is when individuals or households are no better off following a pay increase because tax paid increases and benefits are withdrawn. This reduced incentives for those in low paid employment to earn extra income
        • Fuel poverty = Old age pensioners spend a larger proportion of their income on fuel and therefore can suffer from fuel poverty which is when households spend more than 10% of their income on fuel
      • Government action against poverty and inequality
        • Progressive taxation
          • This is a tax or tax system in which the rich pay a higher proportion of income tax than the poor
        • Regressive taxation
          • A tax imposed which makes the poorer worst off. e.g. VAT The UK tax system is highly progressive and therefore is used to redistribute income and wealth.
        • Transfers to the poor
          • A transfer is an income paid by the state to benefit recipients and financed from taxation. When used alone progressive tax just reduces post tax income differentials not pre tax income differentials
          • Main transfers directed at the poor are pensions and benefits
        • Tax credits
          • Tax credits are a form of negative income tax paid by the government to a person whos income is very low
        • Means tested benefits
          • These are only available to those who most need them
        • The national minimum wage
        • Fiscal drag poverty and low pay
          • Fiscal drag is a failure to raise personal tax thresholds in line with inflation that brings the low paid into the tax net
    • Competition policy
      • Monopolies
        • Competition commision is a government organisation responsible for implementing policy in relation to monopoly. It investigates monopolies and situations that can lead to a monopoly
        • If the CC or OFT have reason to believe the behaviour of the dominant firm is against interest they can:
          • Order firms to stop certain trading practices
          • Enforce price controls
          • Tax excess profits
          • Nationalisation
          • Privatisation
          • Deregulation
      • Mergers
        • These can cause concern as they can cause the formation of monopolies
        • European commission is able to prevent and control mergers in EU member countries
      • Restrictive trade practices
        • These are methods used by firms to reduce competition in a market
        • Individual firms use them to reinforce their dominance and cartels use them to deter competition they include:
          • Price discrimination
          • Resale price maintenance where manufacturers fix the price retailers set at preventing competition
          • Refusal to supply certain outlets or markets
          • Full line forcing - where a supplier makes a firm sell more than one of its productis
    • Public ownership, privatisation, regulation and De regulation of markets
      • Privatisation
        • Advantages
          • Increased competition improves efficiency and reduces X-inefficiency
          • Improves resource allocation they have to react to market signals of supply and demand
          • Promotes competition
        • Disadvantages
          • Privately run monopolies can worsen allocation of resource and therefore are less efficient
          • Privately run firms can ignore negative externalities
          • Closure of loss making services
      • Definitions
        • Public private partnerships- partnerships between the private and public sectors to provide public service
        • Private finance initiatives - A form of public and private partnership where private sector firms do the bulk of the work. Main advantage is improvements can be made with out increasing government borrowing.
        • Nationalised industry is one that is owned by the state. They normally have the interests of consumers at heart as they don't have to make profits.
        • Privatisation is the transfer of a firm from the government to the public sector
      • Regulation
        • Government regulations are rules enforced by the government
        • They are used to reduce market failure by:
          • Reducing use of demerit goods
          • Reducing Monopoly power
          • Providing protection for consumers
        • Firms who dont follow regulation are punnished
        • They can be difficult to set and expensive to enforce
      • Deregulation
        • Removing or reducing regulating removes some barriers to entry and exit so it can increase competition
        • It is used alongside privatisation
        • Advantages
          • It improves resource allocation so markets are more contestable
          • It improves efficiency
        • Disadvantages
          • It is difficult to deregulate some natural monopolies
          • It can't fix other market failures such as negative externalities
          • It can mean less safety and protection for consumers
    • Cost benefit analysis
      • Definition
        • This is a technique for assesing al the costs and benefits likely to result from an economic decisiton. it is normally used to help the government to decide whether to invest in a major project
        • Shadow prices
          • Cost benefit analysis often uses prices that are different from a goods actual price in order to account for costs,benefits, taxes and subsidies
        • Investment appraisal
          • This is a type of CBA used by private sector firms to decide whether to invest. Firms try to put money values to the costs and benefits but this involves guessing and is therefore inaccurate. CBA is one step firther as it estimates social costs and benefits and private costs and benefits therefore it is harder to impliment.
      • Main stages
        • 1. Calculation of social costs and benefits
        • 2. Calculation of tangible costs and benefits
        • 3. Calculation of intangible costs and benefits
        • 4.Sensitivity analysis of events occuring
        • 5. Discounting future value benefits
        • 6. Comparing costs and benefits
        • 7. Comparing net rate of return
      • Advantages
        • Simplicity
          • CBA simplifies complex business decisions as it frames everything into total benefits and total costs
        • Objectivity
          • CBA provides an objective way to compare projects. It removes any emotional attachment to a project
        • Goal setting
          • As benefits are predicted it can give a company and idea of the lowest revenue needed to break even allowing the firm to set revenue goals
      • Disadvantages
        • Varied opinions
          • Different people value different things in different ways
        • Social welfare
          • Social welfare in CBA is found using the Hicks Kaldor test. A CBA can bypass the type of welfare by saying there's a net welfare gain but this could purely be a welfare gain for the rich
        • Forecasting
          • It is hard to forecast all the costs and benefits that might occur in the future. Population distribution and inflation may have different impact on future costs and benefits
        • Objectives
          • CBA can not be used to chose between 2 alternative objectives i.e. it can be used to decide between investing or not but it can't decide what to invest in
    • Government failure
      • Introduction
        • Why do the government intervene?
          • To correct market failure
          • To achieve a more equal distribution of income and wealth
          • To improve perfermance of the ecoonomy
        • What can the government do about demerit goods?
          • Ban
          • Limit production
          • Minimum price
          • Subsidies alternative
          • Limit consumption e.g. age
          • Scheme to support producers
          • Warnings/ inforamtion
          • Laissez - faire
      • Taxes
        • Introduction
          • Governments often achieve their objectives through the application of a tax
          • The reasons for taxing are
            • Deter monopoly abuse
            • Force people to consume merit goods
            • Restrict consumption of demerit goods
            • Control negative externalities
            • Promote positive externalities
          • Indirect taxation is a tax imposed by the government to producers causing a price rise for consumers
        • Unit/specific tax
          • This is the same moneytary tax regardless of the price of the product
          • Aplying the tax causes the supply curve to shift from S1 to S2 this causes a rise in price
          • The more inelastic the demand curve the easier it is for producers to pass tax to consumers
        • Ad Velorem tax
          • This is the same percentage of the price so a higher price is a higher tax e.g. VAT
          • The higher the price the bgger the shift in supply curve with the amount it shifte being the same as the percentage of the tax
      • Subsidies
        • A subsidy is money given by the government in order to encourage the production of a good and lower its price and increase its quantity demanded.
        • It is mainly used for merit goods
      • Minimum price
        • This is a price at whicht he market price can't fall below
        • It must be set above the equilibrium and causes excess supply which can lead to the emergence of secondary markets
      • Maximum price
        • A maximum price is set below the equilibrium price
        • It creates excess demand which can lead to secondary markets
      • Pollution permits
        • These are rights to buy and sell potential pollution
        • It deals with the negative externalities of pollution
        • It is divided between countries and large firms
        • Pollution permits create  a choice for companies emitting high levels of CO2
          • Go green - sell your spare permits for profit
          • Stay dirty - Buy extra permits on the market
      • Moral hazard describes the tendency of individuals and firms once insured against some contingency to behave so as to make the contingency more likely
      • Adverse selection describes a situation in which people who buy insurance often have a better idea of the risks they face than the sellers of insurance

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