Edexcel A Level Economics A:复习笔记1.4.1 Government Intervention in Markets

Government Intervention in Markets

  • Nearly every economy in the world is a mixed economy and has varying degrees of government intervention
  • Governments intervention is necessary for several reasons

1-4-1-reasons-for-government-intervention_edexcel-al-economics

A diagram showing several reasons for government intervention in mixed economic systems

 

  • Correct market failure: in many markets there is a less than optimal allocation of resources from society's point of view
    • In maximising their self-interest, firms and individuals will not self-correct this allocation of resources and there is a role for the government
    • They often achieve this by influencing the level of production or consumption
  • Earn government revenue: governments need money to provide essential services, public and merit goods
    • Revenue is raised through intervention such as taxation, privatisation, sale of licenses (e.g. 5G licenses), and sale of goods/services
  • Promote equity: to reduce the opportunity gap between the rich and poor
  • Support firms: in a global economy, governments choose to support key industries so as to help them remain competitive
  • Support poorer households: poverty has multiple impacts on both the individual and the economy
    • Intervention seeks to redistribute income (tax the rich and give to the poor) so as to reduce the impact of poverty
  • Four of the most common methods used to intervene in markets are indirect taxation, use of subsidies, maximum prices, and minimum prices

Indirect Taxation

  • An indirect tax can be either ad valorem or specific

Ad Valorem Tax

  • Value added tax (VAT) is 20% in the UK in 2022. The more goods/services consumed, the larger the tax bill
    • This causes the second supply curve to diverge from the original supply curve
    • VAT raises significant government revenue

1-4-1-government-intervention---ad-valorem-tax

A diagram showing an ad valorem tax (VAT) and the tax incidence for producers and consumers

 

Diagram Analysis

  • Initial equilibrium is at P1Q1
  • Supply shifts left due to the tax from S → S + tax
    • The two supply curves diverge as percentage tax means more tax is paid at higher prices
  • Consumer incidence of tax is (P2 - P1) x Q2 - Area A
  • Producer incidence of tax is (P1 - P3) x Q2 - Area B
  • New equilibrium is at P2Q2
    • Final price is higher (P2) and QD is lower (Q2)

Specific Tax on Negative Externality of Production

  • Governments frequently tax firms that pollute or create harmful external costs in production

1-4-1-government-intervention---neg--externality-of-production_edexcel-al-economics

A diagram that shows the impact of a tax on a product that is over-provided in society. The tax reduces the welfare loss and moves production closer to the optimum level of production

 

Diagram Analysis

  • The free-market equilibrium is at PeQe - where MSB = MPC
    • Market failure exists as MSC > MSB at equilibrium
    • Optimum level of output is at Qopt
    • There is over-provision of this product
  • A specific tax shifts the supply curve left from S → S1
    • The tax does not completely eradicate the welfare loss but moves the market closer to the optimum level of output (Qopt)
    • The welfare loss has been reduced as shown in the diagram
  • The new market equilibrium is at P1Q1
    • This is a higher price and less output
    • There is less over-provision and so less market failure
    • The external costs have been reduced

Specific Tax on Negative Externality of Consumption

  • Governments frequently tax demerit goods such as cigarettes, alcohol, fatty foods, and polluting vehicles

1-4-1-government-intervention---neg--externality-of-consumption_edexcel-al-economics

A diagram that shows the impact of a tax on a product that is over-consumed in society. The tax reduces the welfare loss and moves consumption closer to the optimum level of production

 

Diagram Analysis

  • The free-market equilibrium is at PeQe - where MPB = MSC
    • Market failure exists as MSC > MSB at equilibrium
    • Optimum level of consumption is at Qopt
    • There is over-consumption of this product
  • A specific tax shifts the supply curve left from S → S1
    • The tax does not completely eradicate the welfare loss but moves the market closer to the optimum level of output (Qopt)
    • The welfare loss has been reduced as shown in the diagram
  • The new market equilibrium is at P1Q1
    • This is a higher price and lower output
    • There is less over-consumption and so less market failure
    • The external costs have been reduced

Subsidies

  • Governments frequently use subsidies to encourage production/consumption of merit goods such as energy efficient products, electric vehicles, healthcare, and education

1-4-1-government-intervention---subsidies_edexcel-al-economics

A diagram that shows the impact of a subsidy on a product that is under-consumed in society. The subsidy reduces the potential welfare gain and moves consumption closer to the optimum level

 

Diagram Analysis

  • The free-market equilibrium is at PeQe - where MPB = MSC
    • Market failure exists as MSB > MSC at equilibrium
    • Optimum level of output is at Qopt
    • There is under-consumption of this product
  • A subsidy shifts the supply curve right from S → S1
    • It does not completely eradicate the potential welfare gain but moves the market closer to the optimum level of output (Qopt)
    • The potential welfare gain has been reduced as shown in the diagram
  • The new market equilibrium is at P1Q1
    • This is a lower price and higher output
    • There is less under-consumption and so less market failure
    • Some of the external benefits available have been realised

Maximum Prices

  • Governments will often use maximum prices in order to help consumers. Sometimes they are used for long periods of time e.g. housing rental markets. Other times they are short-term solutions to unusual price increases e.g. petrol
  • A maximum price is set by the government below the existing free market equilibrium price and sellers cannot legally sell the good/service at a higher price

1-4-1-government-intervention---maximum-price_edexcel-al-economics

A diagram that shows the imposition of a maximum price (Pmax) which sits below the free market price (Pe) and creates a condition of excess demand (shortage)

 

Diagram Analysis

  • Initial market equilibrium is at PeQe
  • A maximum price is imposed at Pmax
    • The lower price reduces the incentive to supply and there is contraction in QS from Qe → Qs
    • The lower price increases the incentive to consume and there is an extension in QD from Qe → Qd
    • This creates a condition of excess demand QsQd
  • Some consumers benefit as they purchase at lower prices
    • Others are unable to purchase due to the shortage
    • This unmet demand usually encourages the creation of illegal markets (black/grey markets)

Minimum Prices

  • Governments will often use minimum prices in order to help producers or to decrease consumption of a demerit good e.g. alcohol
  • A minimum price is set by the government above the existing free market equilibrium price and sellers cannot legally sell the good/service at a lower price
  • Minimum prices are also used in the labour market to protect workers from wage exploitation. These are called minimum wages

1-4-1-government-intervention---minimum-price_edexcel-al-economics

A diagram that shows the imposition of a minimum price (Pmin) which sits above the free market price (Pe) and creates a condition of excess supply (surplus)

 

Diagram Analysis

  • Initial market equilibrium is at PeQe
  • A minimum price is imposed at Pmin
    • The higher price increases the incentive to supply and there is an extension in QS from Qe → Qs
    • The higher price decreases the incentive to consume and there is a contraction in QD from Qe → Qd
    • This creates a condition of excess supply QdQs

Differences in Government Responses to the Excess Supply

  • In agricultural markets, if a minimum price is set by the government producers benefit as they receive a higher price
    • Governments will often purchase the excess supply and export it
  • In demerit markets, producers suffer as QD contracts
    • Governments will not purchase the excess supply
    • Producers usually lower their output in the market to match the QD at the minimum price

Other Methods of Government Intervention

Trade Pollution Permits

  • Governments create a pollution permit market and issue permits to polluting firms
    • This helps to reduce negative externalities of production
    • Each permit is typically valid for the emission of one ton of pollutant
    • More polluting firms have to buy additional permits from less polluting firms
    • The price of the permit represents an additional cost of production
  • If the price of additional permits is more than the cost of investing in new pollution technology, firms will be incentivised to switch to cleaner technology:
    • Firms can then sell their spare permits and gain additional revenue

State Provision of Public Goods

  • Public goods are beneficial for society and are not provided by private firms due to the free rider problem
  • They are usually provided free at the point of consumption, but are paid for through general taxation
  • Examples include roads, parks, lighthouses, national defence

Provision of Information

  • Information gaps cause market failure
  • Governments can set up information portals so as to reduce the asymmetric information
  • Examples include job centres, consumer rights websites, nutritional labels

Regulation

  • Governments create rules to limit harm from negative externalities of consumption/production
    • They create regulatory agencies to monitor that the rules are not broken
    • There are more than 90 regulators in the UK
    • Individuals or firms may be fined/imprisoned for breaking the rules
  • Examples of some industry regulators include the Environment Agency, Ofsted, and the Financial Conduct Authority

 

 

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