Government intervention to correct market failure Date: What is the best option that the government could use to deal with demerit goods? Learn about government intervention to deal with demerit goods. Learning objective: STARTER: What could the UK government do to deal with Obesity? What are the advantages and disadvantages of each option?

Key Words Market Failure - when markets don’t allocate resources efficiently. Indirect tax - a tax paid by firms (and indirectly by the consumers of their product) e.g. V.A.T. Direct tax - a tax paid, directly to the government, by the individual e.g. P.A.Y.E. Subsidy - a payment by the government to firms that reduce their costs of production and encourages them to increase output and consumption. Regulation - rules set by the government that seek to control behaviour. Tradeable Permit - give a firm the right to emit a given quantity of waste or pollution into the environment. Ideally, the number of permits that are issued corresponds with the total level of pollution that is admissible at the social optimum level of output. LESSON OBJECTIVES Be able to evaluate the impact of indirect taxes, subsidies, regulation, tradeable pollution permits and the provision of information as possible solutions to market failure created by demerit goods. Be able to use demand and supply diagrams to illustrate market failures to illustrate the impact of government policies to correct market failure.

Possible solutions to market failure What is the best option that the government could use to deal with demerit goods? ExplanationAdvantagesDisadvantages Use taxation Provide information Legal restrictions (regulate or ban) Use Subsidies Tradeable permits

GOVERNMENT INTERVENTION What is the best option that the government could use to deal with demerit goods? The main reasons for policy intervention are: 1.To correct for market failure 2.To achieve a more equitable distribution of income and wealth 3.To improve the performance of the economy

WHO CARES? STAKEHOLDERS What is the best option that the government could use to deal with demerit goods? A stakeholder is any person or organization that has a legitimate interest in a specific project or policy decision. NAME ALL THE PEOPLE THAT ARE EFFECTED BY GOV DECISIONS

WHO CARES? STAKEHOLDERS What is the best option that the government could use to deal with demerit goods? Examples of stakeholders you might think of bringing into a discussion Employees of a business / organisation (who may / may not be members of a union) Communities where a business is located or affected directly by a decision Suppliers to a particular business (e.g. back down the supply chain) Shareholders and other investors / financiers Creditors (people owed money) Government (and through them – taxpayers) Trade unions (and the workers they represent) Professional associations NGOs and other advocacy groups (i.e. World Bank, IMF, Pressure Groups) Prospective employees Prospective customers Local communities National communities International community Competitors within a market

WHO CARES? STAKEHOLDERS What is the best option that the government could use to deal with demerit goods? Stakeholders affected by all kinds of issues including the following: 1.Increasing the national minimum wage 2.Rise in the London Congestion charge and expansion of the congestion charge zone 3.The building and opening of Heathrow Terminal 5 4.Government investment in wind farm technology 5.Reforms to the EU’s common agricultural policy 6.Possible introduction of a tax on aviation fuel for flights inside the EU 7.Key decisions on developing new towns to help meet the demand for housing 8.Food export bans and export taxes (e.g. India increasing the tax on exported rice) 9.Decisions to lower import tariffs on goods and services coming into the UK 10.Changes to rules on mortgage lending as a result of the credit crunch 11.Higher tuition fees for UK students at English universities

LETS EVALUATE: What does evaluation look like? Effectiveness of a policy: Questioning the extent to which a policy tool will be effective e.g. price elasticity of demand will influence the efficacy of an indirect tax. Efficiency of a policy: i.e. does a particular intervention lead to a better use of scarce resources among competing ends? does it improve allocative, productive and dynamic efficiency? For example - would introducing indirect taxes on high fat foods be an efficient way of reducing some of the external costs linked to the growing problem of obesity? Comparing options e.g. is a subsidy more effective than a tax. What the decision will depend upon: outside factors Sustainability of a policy: Short term v long term. Does a policy reduce the ability of future generations to engage in economic activity? Inter-generational equity is an important issue – in particular on which sources of energy we rely on in future years. Equity effects of intervention: Questioning the fairness of a policy e.g. are indirect taxes fair? The opportunity cost of a subsidy. i.e. is a policy thought of as fair or does one group in society gain more than another? For example it is equitable for the government to offer educational maintenance allowances (payments) for year olds in low income households to stay on in education after GCSEs? Would it be equitable for the government to increase the top rate of income tax to 50 per cent in a bid to make the distribution of income more equal?

What to include in your answer to an 18 mark question … Marks are awarded for these questions based upon your level of response. There are 4 levels … Level 1 (1 – 4) – Knowledge e.g. accurate definitions of key words/terms (such as those used in the question) Level 2 – (5 – 8) Application of knowledge/using knowledge whilst attempting to answer the question e.g. explaining why an indirect tax on fatty foods might reduce levels of Obesity. Using examples to show how the policy might be interested. Level 3 – (9 – 12) Analysis/using economic theory to explain something e.g. supply and demand analysis (diagram which is explained) to explain why an indirect tax might reduce levels of Obesity. Level 4 – Evaluation (13 – 18) You can’t access a higher level of marks unless you have achieved the levels below it. What is the best option that the government could use to deal with demerit goods?

Questions/topics set in past exams … Jan 09 - should the government subsidise food prices? Jun 09 - are taxes the best solution for dealing with negative externalities? Jan 10 – should healthcare be provided by the public or private sector? Jun 10 – should taxes on petrol be reduced? Jan 11 - is regulation the best way to deal with carbon emissions? Jun 11 - are subsidies a good way to encourage the consumption of merit goods/goods with positive externalities? Jan 12 – what is the best option for dealing with the problems created by discarded chewing gum? Jun 12 – is regulation alone the best way to deal with the problems created by fast food? Jan 13 – are subsidies to build affordable housing the best way to deal with the housing shortage? What is the best option that the government could use to deal with demerit goods?