Microeconomics Topic 5a: Government intervention Unit content Students should be able to: Define methods of government intervention to correct market failure and use diagrams (indirect taxation (ad valorem and specific), subsidies, maximum and minimum prices; tradable pollution permits, provision of information; state provision of public goods and regulation) Apply, analyse and assess the effectiveness of each method Students should be able to apply government economic measures in various contexts, for example, road pricing, landfill tax, carbon offsetting and carbon emissions trading, renewable energy certificates.  

What is government intervention?

Why do governments intervene in the economy?

How do governments intervene? Financial intervention By legislation and regulation Direct provision of goods and services

Financial intervention Microeconomics Topic 5a: Government intervention Financial intervention This can be used to alter the level of demand for different products within the economy. There are two methods on your syllabus: indirect t_______ s___________ Also: tax relief and changes to taxation and welfare payments

Microeconomics Topic 5a: Government intervention Indirect taxes (see 1.2.9) What are indirect taxes? A payment to the government that is levied on specified goods and services – it is indirect as it is only paid when the product is _____________ What are they used for? To manage consumption of d_______ goods that generate ____________ externalities by __________ the price. E.g. The opposite of an indirect tax is a tax levied directly on income (a direct tax).

Microeconomics Topic 5a: Government intervention Example Complete the table below and plot the three supply curves, what do you notice? Quantity supplied Original price (£) Original price increased by 20% Original price increased by £2 1 5 4 10 7 15 20 The opposite of an indirect tax is a tax levied directly on income (a direct tax).

Indirect taxes – ad valorem tax An ad valorem tax is a tax which is calculated as a __________ of the value of an item E.g. The opposite is a specific tax which is when a ____ amount is added to the value of each item. Why might this be seen as unfair?

Calculating tax example Microeconomics Topic 5a: Government intervention Calculating tax example Plot the table below and comment on the equilibrium. The government impose a specific tax of £3 per unit. Show the effect of this. What is the tax incidence for the consumer and the producer? How much tax is the consumer paying in total? The firm? How much does the government receive? Price (£) Quantity demanded Quantity supplied 4 16 6 12 8 10 The opposite of an indirect tax is a tax levied directly on income (a direct tax).

Diagram Draw a diagram showing negative production externalities corrected by financial intervention (a specific tax)

Subsidies What are they? Financial intervention to address market failure caused by external benefits or positive externalities will be in the form of a subsidy.

What are subsidies used for? to lower the price of ________ goods to increase consumption of a product with external benefits (__________ externalities) to lower the price of __________ products to maintain or increase _______________ (sometimes in vulnerable industries) What effect does a subsidy have on the demand curve?

Externalities: financial intervention - subsidies If the government want to encourage more consumption they may offer subsidies to the producers. Draw a diagram showing a subsidy. Write a brief explanation

Externalities: intervention - information Draw a diagram showing the effect of providing information for a good with positive externalities

Externalities: information and subsidies What happens if the government offer subsidies to the producers and run a successful campaign to persuade consumers of the benefit of the good? Draw this

Externalities: pollution permits What is market failure? When the price mechanism leads to an inefficient use of resources e.g. pollution is created (external cost) and is not paid for by the industry. One method of controlling pollution is by the use of pollution permits. The government issues/sells permits to firms allowing them to _______________________________ These permits can be traded, creating an incentive for firms to be relatively ‘clean’ so that if they don’t use up their full allocation they can sell it. Permits increase the MPC of the firms hence internalising the externality so that MPC =

Externalities: pollution permits Firms with relatively inefficient production methods will face ______ overall costs and should be encouraged to generate ______ pollution. The system also allows governments to control the ________ amount of pollution generated. However _______________ is required as well as an ___________________

Direct provision of goods and services Because of privatisation, the state-owned sector of the UK economy is much _______ than it was before 1980. The main state-owned business in the UK is _________________ State funding can also be used to provide merit and public goods and services. E.g. the government pays private sector firms to operate __________ and maintain our ___________

Direct provision of goods and services Although some people argue against government intervention, nearly everyone believes that taxes should be used to provide public goods. What is the drawback of the government providing a good free to the consumer?

Public goods Public goods (e.g. ________) need to be financed by the government, but need not be produced by them. The government will decide upon the optimum level of defence expenditure and raise revenue through ________ to fund it. The issue facing the government is deciding upon the fairest or most equitable way of raising the tax revenue required.

Government legislation and regulation Parliament can pass laws e.g. prohibiting the sale of cigarettes to under 18s or banning smoking in public places. Competition laws act against examples of price-fixing or other forms of anti-competitive behaviour Employment laws offer some protection for workers e.g.

Government appointed regulators Government appointed regulators can impose price controls in most of the main utilities such as telecommunications. Free market economists criticise this – why? Regulation can also be used to introduce new competition for example by breaking up a monopoly e.g. telecommunication

Externalities: regulation Governments frequently use regulation to address market failures caused by externalities. A factory producing chemicals may pollute the local river and the government might intervene by setting limits that restrict the amount of pollution allowed. The government would then need to regulate and inspect the company and fine them if they exceed their limits.

Correcting information failures Microeconomics Topic 5c: Government intervention Correcting information failures Shops are legally obliged to provide the consumer with information e.g. Similarly, consumers are legally protected from being sold faulty products or with misleading information. Compulsory labelling on cigarettes and nutritional labelling of food and drink are designed to?

Example - smoking

Price intervention – maximum prices The government can legally impose a maximum price ceiling in a market, that suppliers can’t exceed. The aim is to prevent the market price from rising above a certain level. To be effective a maximum price has to be set ___________ the free market price.

Price intervention – maximum prices NOTE: what would be the impact of a price ceiling set above the free market equilibrium price?

Price intervention – minimum prices Similarly a minimum price is a legally imposed price floor, below which the normal market price cannot fall. To be effective the minimum price has to be set _______ the normal equilibrium price.

Price intervention – minimum prices The National Minimum wage was introduced into the UK in ______ It is an intervention in the labour market designed to ? The minimum wage is a price ________ and applies to both full time and part time workers.

Price intervention – minimum prices There are three levels of minimum wage, and the rates from 1 October 2015 are: £ per hour for workers aged 21 years and older £ per hour for workers aged 18-20 inclusive £ per hour for all workers under 18 £ for (young) apprentices

Price intervention – minimum prices Draw a diagram showing the impact of the minimum wage. Describe your diagram briefly. What is the drawback?