Government Intervention

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  • Created by: JonTurpin
  • Created on: 11-01-18 12:47

Taxation

Governments us indirect taxes to affect the supply of some goods/services

Specific taxes: these are a fixed amount that's charged per unit of a particular good, no matter what the price of that good is

Ad valorem taxes: these are charged as a proportion of the price of a good e.g. 20% tax on the price of the good

  • Indirect taxes increase costs for producers so they cause the supply curve to shift to the left
  • Governments often put extra indirect taxes on goods that have negative externalities, such as petrol, alcohol and tobacco
  • The aim of taxation is to internalise the externality that the good produces. The taxes make revenue for the government which can be used to offset the effects of the externalities
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Subsidies

  • The government may pay subsidies with the aim of encouraging the production and consumption of goods and services with positive externalities. A subsidy increases the supply of a good/service, so the supply curve shifts to the right
  • Subsidies can be used to encourage the purchase and use of goods/services which reduce negative externalities, or as support for firms to help become more internationally competitive

Advantages:

  • Goods with positive externalities have their costs covered by the government subsidy, leading to a lower price for consumers
  • Subsidies can support a domestic industry until it grows to the point that it can exploit EoS and become internationally competitive
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Price Controls

  • Governments can set a maximum or minimum price for a good or service
  • A maximum price (or price ceiling) may be set to increase consumption of a merit good or to make a necessity more affordable
  • If a maximum price is set above the market equilibrium price, it will have no impact
  • If it's set below the market equilibrium, it will lead to excess demand and a shortage in supply
  • Minimum prices (or price floors) are often set to make sure that suppliers get a fair price
  • If a minimum price is set below the market equilibrium, it will have no impact
  • If it's set above the market equilibrium price, it will reduce demand and increase supply, leading to excess supply
  • To make a minimum price for a good work the government must purchase the excess supply at the guaranteed minimum price. This will then be stockpiled or destroyed.
  • Minimum prices are a good way to stop monopsony power
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State Provision

State provision is where the government provides certain goods or services

  • Governments use tax revenue to pay for certain goods and services so that they're free, or largely free, when consumed. E.g. NHS, state education, police services (UK)
  • Public goods, such as defence and street lighting, are also provided by the state
  • State provision can come directly from the government or alternatively , governments can purchase the good or service from the private sector and provide it to the public for free
  • Free provision of services can help to reduce inequalities in access e.g. due to differences in wealth
  • It can also redistribute income-most of the money to pay for the services come from taxing wealthier citizens
  • State provision means there's less incentive to operate efficiently due to the absence of the price mechanism
  • State provision may fail to respond to consumer demads, as it lacks the motive of profit
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Privatisation

Privatisation: the transfer of the ownership of a firm/industry from the public sector to the private sector

Advantages:

  • Increased competition improves effeciency
  • Improves resource allocation

Disadvantages:

  • May have less focus on safety and quality because they have more focus on profits and costs
  • New private firm may need regulating to prevent it from being a private monopoly
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Regulation and Deregulation

Regulations: rules that are enforced by an authority (e.g. a government) and they're usually backed up with legislation

  • Reducing the use of demerit goods and services-e.g. by banning or limiting the sale of such products
  • Reducing the power of monopolies-e.g. using a regulating body to set rules such as price caps
  • Providing some protection for consumers and producers from problems arising from aysmmetric information

With appropiate legislation, firms or individuals who don't follow the regulations can be punished e.g. with fines

Deregulation: removing or reducing regulations. It removes some barriers to entry, so it can be used to increase competition in markets, particularly monopolistic markets, and tackle market failure

  • Deregulation is used alongside/as part of privatisation
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Competition Policy

Competition policy aims to increase competition in a market

  • Governments often choose to intervene in concentrated markets where monopoly power is causing market failure
  • The intention of the government is to protect the interests of consumers by promoting competition and encouraging the market to function more efficiently. They can do this through competition policy

Governments often want to prevent monopolies from forming-Things they look out for include:

  • Mergers: they monitor mergers and takeovers so they can prevent those that aren't benficial to the efficiency of the market or to consumers. They may choose to stop a merger that would give a firm too high a market share and make it a monopoly, or that would give it too much monopoly power
  • Agreements: between firms (e.g. cartels, collusive oligopolies)
  • The opening of markets to competition: markets that are controlled by a gov. are opened up to competition
  • Financial support from gov's: financial support from other gov's may create an unfair advantage
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Competition Policy

There are many ways a government can intervene in a market to try and increase competition

  • Privatisation can introduce competition into a market where there's a public monopoly
  • Regulation can be used to control or prevent monopoly power
  • Deregulation can also be used to increase competition
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Government Failure

Government failure: when government intervention causes a misallocation of resources in a market

Government failure is an unintended consequence of an intervention to correct a market failure

Government interventions can cause market distortions, e.g:

  • Income taxes can act as a disincentive to working hard-an increase in income will result in paying more tax
  • Governmental price fixing, such as max and min prices, can lead to the distortions of price signals
  • Subsidies may encourage firms to be inefficient by removing the incentive to be efficient

Government failure can be caused by imperfect or aysmmetric information

  • Imperfect or aysmmetric information can mean it's difficult to asses the extent of market failure
  • Governments may not know how the population wants resources to be allocated
  • Governments don't always know how consumers will react
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