Transcript The Economic Problem

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
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
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___________
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.
Example
Complete the table below and plot the three
supply curves, what do you notice?
Quantity
supplied
Original
price
(£)
1
5
4
10
7
15
10
20
Original
price
increased
by 20%
Original
price
increased
by £2
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
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
4
6
12
6
8
8
8
10
4
10
12
0
12
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 anticompetitive 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
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 theP1
minimum wage. Describe your diagram
briefly.
What is the drawback?