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Government Intervention - Coggle Diagram
Government Intervention
Government failure
This exists when an intervention leads to a depper market failure or, even worse, a new failure may arise. This is when intervention creates further inefficiencies, a misallocation of resources and a loss of economic and social welfare.
Policies may have damaging long-term consequences for the economy or society. Policies may be ineffective in meeting their stated aims. Policies may create more losers than winners. Government failure can happen if a policy decision fails to create enough of an incentive t change people's actual behaviour
Political self-interest, poor value for money, policy short-termism, regulatory capture, conflicting objectives, bureaucracy and red tape, unintended consequences
Unintended consequences - Well-intended legisaltion often acts against the interests of those it is intended to serve. People and businesses find ways to circumvent new laws. Shadow markets develop to undermine an offical policy
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Direct provision
Direct provision of a public good by the government can help to overcome the free-rider problem which is the cause of market failure. The non-rival nature of consumption provides a strong case for the government, rather than the market, to provide and pay for public goods. Many public goods are provided more or less free at the point of use and then paid for out of general taxation or another form of charge, such as a licence fee.
Governments can provide state funding to private sector companies who can then provide the good. This is thought to improve productive efficiency due to the profit motive. However, government provision can be efficient as they are producing on a large scae, so can achieve economies of scale.
In the case of merit goods, direct provision can prevent the under-provision and under-consumption problem which causes market failure. However, as merit goods often include a value judgement, some people think that not all merit goods should be directly provided by the government. There is an opportunity cost as they are paid for with taxpayers' money.
Indirect taxation
An indirect tax is a tax collected by an intermediary, from the person who bears the ultimate economic burden of the tax. They can be specific/unit tax or ad valorem.
Reasons for imposing tax are to generate government revenues, to discourage consumption and to alter the pattern of consumption. Indirect tax is a policy option for demerit goods or goods that generate negative externalities
Price inelastic demand is relatively ineffective. Quantity demanded only falls by a small amount. Even with the price rise, many people will still demand an inelastic goods. Tax will only reduce demand by a small amount
Price elastic demand is relatively effective. Tax will cause demand to decrease by a greater amount. Therefore, an imposition of a tax will be more effective if the good is price elastic. More elastic means indirect tax is more effective
The incidence of tax (the amount the consumer and producer pay) is determined by the price elasticity of demand. If the good is relatively prive inelastic, then the producer can pass no most of the tax to the consumer. When the good is relatively price elastic, then the producer has to bear the brunt of the tax
Evaluation - depends on coefficient og PED, problems with setting tex rate at the right level, unintended consequences, possible loss of jobs or captial investment, affect competitiveness and trade, regressive effect on lower income groups
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Subsidies
A subsidy is a payment by the government to suppliers that reduces their costs of productin and encourages them to increase output. They are used in markets where there is under-production and under-consumption, typically merit goods and positive externalities
The effectiveness depends on PED. The more inelastic the demand, the great the consumer's gain from a subsidy. When demand is perfectly inelastic, the consumer gains most of the benefit from the subsidy. When demand is relatively price elastic, the main effect of the subsidy is to increase the equilibrium quantity traded, rather than to lead to much lower market prices.
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Evaluation - depends on PED, possible extra burden for taxpayers, unintended consequences, other incentives may be needed
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Regulation
Refers to the government rules and laws to correct market failure. They can be used as a form of intervention in markets where negative externalities occur but they can be used for other types of market failure
Government appointed regulators can impose price controls on most of the main utilities to regulate monopolies. They may introduce fresh competition into a market. This is known as market liberalisation
Evaluation - high cost of enforcement, unintended consequences, cost of meeting regulations can discourage small businesses and lower competition in markets, free-market economists criticise the scale of regulation arguing that it creates an unnecessary burden of costs for businesses
Maximum pricing
The government or an industry regulator can set a price cap to prevent the market price from rising above a certain level. They can be used in monopoly markets or markets where the suppliers have a monopoly power. It is deemed that the consumer needs protecting
Problem is that it creates excess demand, and so, black markets can be created. This is an illegal market in which the market price is higher than a legally imposed price ceiling. Some consumers are prepared to pay higher prices in black markets in order to get the goods or services they want.
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Evaluation - reduces profits so less money for investment, may dissuade new entrants, firms might raise prices in other ways
Minimum pricing
Minimum prices are price floors and are most commonly associated with minimum wages in the labour markets or guaranteed price support schemes for farmers or other producers. Sometimes they are used for demerit goods
Evaluation - could cause unemployment, inequality
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