Government intervention in the market

Why do the government intervene in a market?

To correct market failure, To improve performance in the economy, to achieve a more equal distribution of income and wealth

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What can the government do about demerit goods?

Ban, limit production, minimum price, subsidise alternative, limit age, scheme to support producers, warnings/information, laissez faire

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Define Unit/specific tax and relate it to elastitcity

This is the same moneytary tax regardless of the price, the more inelastic the demand curve the easier it is for producers to pass the tax on to consumers

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What are the reasons for taxing?

Restrict consumption of demerit goods, control negative externalities, Deter monopoly abuse, force people to consume merit goods, promote positive externalities

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Define Ad velorem tax

This is the same percentage of a price so a higher price means more tax e.g. VAT

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Define Subsidy and relate it to elasticity

A subsidy is given by the government to encourage the production of a good and lower its price and increase its demand, the more inelastic the demand curve the more the producer recieves

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Explain a minimum price

This is a price at which the market price can't fall below, It must be set above the equilibrium and causes excess supply leading to secondary markets

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Explain a maximum price

It is set by the government or an industry to prevent the market rising above a certain level its set below the equilibrium price and causes excess demand

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Explain pollution permits

These are rights to buy and sell potential pollution a company either go's green and sells their permits for profit or has to buy extra permits

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Define Moral Hazard

The tendency of individuals and firms once insured against some contingency to behave so as to make it more likely

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Define Adverse selection

A situation in which people who buy insurance often have a better idea of the risks they face than the insurance companies

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Define public private partnership

Partnerships between the private and public sectors to provide the public service

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Define privatisation

The transfer of a firm from the government to the public sector

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Define private finance initiatives

A form of public and private partnership where private sector firms do the bulk of the work. The main advantage is improvements can be made without increasing government borrowing

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Define Nationalised industries

Industries that are covered by the state. They normally have the interests of consumers at heart as they don't have to make profits

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What are the advantages of privatisation?

promotes competition, improves efficiency and reduces X inefficiency, improves resource allocation

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What are the disadvantages of privatsation?

Closure of loss making firms, privately run firms can ignore more negative externalities, can worsen allocation of scarce resources and are less efficient

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Explain regulation

These are rules set by the government, they are difficult to set and expensive to enforce

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How are regulations used to reduce market failure?

Reducing the use of demerit goods, providing protection for consumers, reducing monopoly power

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Define deregulation

Reducing regulation removes some barriers to entry and so increases competition, its used alongside privatisation

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What are the advantages of deregulation?

Improves efficiency, improves resource allocation so markets are more contestable

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What are the disadvantages of deregulation?

It is difficult to deregulate some natural monopolies, it can't fix other market failures like negative externalities, can mean less safety and protection for consumers

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What is the competition commision

A government organisation responsible for implementing policy in relation to monopoly. It investigates monopolies and situations that can lead to a monopoly.

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What can the competition commission or the office of fair trading do if the behaviour of a dominant firm is against public interest?

order firms to stop certain trading practices, enforce price controls, tax excess profits, nationalisation, privatisation, deregulation

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Define restrictive trading practices

These are methods used by firms to reduce competition in a market individuals use them to reinforce their dominance.

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What are examples of restrictive trading practices?

Price discrimination, resale price maintenance ( where manufacturers fix the price retailers sell at), refusal to supply certain outlets or markets, full line forcing (where a supplier makes a firm sell more than one of its products)

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Explain equality

It is a positive statement and occurs when people are equal and can be achieved by things like reducing wage differentials, increasing the amount of money you need before you're taxed increases equality

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Define equity

It is a normative statement and means fairness of justice

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Define vertical equity

Means people with higher incomes should pay more which can lead to the redistribution of income and wealth due to progressive taxes

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Define horizontal equity

Means we give the same treatment to people in an identical situation so income tax is the same for both, reducing discrimination

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What actions can the government take against poverty and inequality?

The national minimum wage, progressive taxation, regressive taxation, transfers to the poor, tax credits, means tested benefits, fiscal drag poverty

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Define progressive taxes

This is a tax or tax system in which the rich pay a higher proportion of tax than the poor

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Define Reressive taxation

A tax imposed which makes the poor poorer e.g. VAT the uk tax system is highly progressive and is used to redistribute income and wealth

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Define transfers to the poor

A transfer is an income paid b the state to benefit recipients an is financed through taxation e.g. benefits and pensions

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Define tax credits

A form of negative income tax paid by the government to a person on low income

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Define fiscal drag

Fiscal drag is a failure to raise personal tax thresholds in line with inflation that brings the lower paid into the tax net

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What are the causes of poverty?

Sickness. disability, imperfect information, regressive taxes, low wages, unemployment, old age

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How is poverty measured?

There is no official measure but the Joseph Rowntree foundation defines poverty as when a households disposable income is less than 60% of the UK median

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Define 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

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What is the poverty audit?

An assessment of the governments performance in eradicating poverty

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Define the poverty trap

When individuals of households are no better off following a pay increase because tax paid increases and benefits are withdrawn. This reduces incentives

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Define relative poverty

This occurs when income is below a specified proportion of the average income. It works by comparing families to others in the population. It is more of an issue in the UK because it is a highly developed economy

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Define absolute poverty

This occurs when income is below a particular level it means the same standard is measured across different locations and times it makes comparison easier but doesn't take into account different levels of income reqiured for different locations

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Explain markets failing inequitably

It occurs when the signalling, incentive or allocative function breaks down and when there are highly unequal distributions of income and wealth

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Define partial market failure

When the market functions but produces the wrong quantity of a product at the wrong price

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Define missing markets

When the incentive function of prices doesn't work at all and a market fails to come into existence or disappears completely

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Define complete market failure

When the market doesn't supply products at all

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Explain markets failing inefficiently

It occurs when the wrong quantity is produced in a market where there are no economies of scale so the wrong price is charged, the market is allocatively and productively inefficient. E.G. monopolies

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What is the price mechanism?

the means by which decisions taken by consumers and businesses in order to determine the allocation of scarce resources. It has 3 main functions.

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Describe the signalling function

Prices provide information that allows the traders in the market to plan and coordinate their economic activity so higher demand signals to producers to increase production, higher supply signals to consumers that their income has increased

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Describe the incentive function

The information signalled by relative prices creates incentives for people to alter economic behaviour

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Describe the rationing function

Prices and income rations the way people spend their money as prices ration scarce resources when demand is greater than supply

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Define negative externalities

This occurs when the production/consumption of a good imposes external costs on third parties outside the market

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Define positive externalities

These occur when the production/consumption of a good imposes external benefits on third parties outside the market, the good may be underconsumed or under provided as the free market fails to value them correctly

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Relate externalities and efficiency

There must be no externalities for allocative efficiency to occur. For efficiency to occur P must = MC

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Define public bads

A bad for which the producers free ride dumping the bad on third parties

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Define Quasi public goods

Goods that are essentially public goods but do not fully exhibit the features non excludable and non rival

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Define public goods

Goods that are non exludable and non rival they can lead to market failure

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Define private goods

Goods that are excludable and rival

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Define merit goods

Goods and services that the government feels that left to the free market people will under consume

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Define demerit goods

Goods thought to be bad for you the consumption of demerit goods leads to negative externalities, consumers are unaware of these externalities dues to imperfect information

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Define cost benefit analysis

A technique for assessing all the costs and benefits likely to result from an economic decision

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Define investment appraisal

A type of CBA used by private sector firms to decide whether to invest, Firms put money values to the costs and benefits. It involves guessing and so can be inaccurate

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Define shadow pricing

Cost benefit analysis often uses prices that are different from a goods actual price in order to account for costs and benefits these fake prices are shadow prices

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What are the advantages of cost benefit analysis?

Simplicity ( CBA simplifies complex business decisions as it frames everything into total benefits and costs), Objectivity ( CBA provide an objective way to compare projects and removes any emotional attachment),

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What are the advantages of cost benefit analysis?

Goal setting (as benefits are predicted it can give a company an idea of the lowest revenue needed to break even)

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What are the disadvantages of cost benefit analysis?

Forecasting ( It is hard to forecast all the costs and benefits that might occur as population distribution and inflation might vary), Objectives (CBA can not be used to chose between 2 alternative objectives),

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What are the disadvantages of cost benefit analysis?

Social Welfare (social welfare in CBA is found using the Hicks Kaldor test, there welfare gain isn't always spread equally and can be just for the rich) , Varied opinions

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Define Property rights

A right provided by the law to determine how a resource is used whether that resource is owned by the government or by individuals, they can be bought or sold.

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Explain the law of unintended consequences

It predicts that whenever the government intervene in the market there are unintended consequences both good or bad

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Explain public choice theory

A theory that if the problem was left to the free market it achieves a better outcome than if the government had intervened as the government can be bias

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Explain public interest theory

This theory supports government intervention in the market as it believes the government intervene with best intentions in order to achieve economic efficiency

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Government intervention in the market

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