a) Purpose of intervention with reference to market failure and using diagrams in various contexts:
Indirect taxation (ad valorem and specific)
Ad Valorem tax
Ad valorem tax is charged as a % of the price of a good or service – leads to an inward shift but with diverging supply curves
Whilst some of these taxes are passed on to the consumer in terms of higher prices – the producer ultimately has to pay the tax to the government
Greater the amount of units of output that are produced, the more tax that is paid
VAT is the main example, currently at 20%
Maximum Price Control
When government intervenes in a market to set a maximum price at which producers are able to sell at
Maximum is always below the free market equilibrium price (which they deem too high) for it to have any effect on price and output
b) Other methods of government intervention:
Trade pollution permits
Carbon Trading
Market-based system aimed at reducing greenhouse gases contributing to global warming, particularly carbon dioxide emitted by burning fossil fuels
How does it work?
Allows richer countries to cut emissions by paying for the development of carbon lowering schemes in poorer nations
• Research indicates some of these schemes have created more emissions than they have curtailed – effectiveness questioned
Cap and trade schemes set overall limit or cap on amount of emissions allowed from significant sources of carbon, including the power industry, car and air travel
• Can be at regional, national or international levels
Governments then issue permits up to agreed limit – either given free or auctioned to companies in the sector
If a company curbs its own carbon significantly – can trade the excess permits on the carbon market for cash – if it is unable to limit its emissions it may have to buy extra permits
These schemes are implemented in EU and in several regions in USA but not nationall
Alternatives
Carbon taxes
In place in many European countries, India, Japan and South Korea – repealed in Australia
Direct Regulations
In place in US and other places
State provision of public goods
Provision of information and Regulation
Government Intervention and Regulation
Regulation – legally enforced laws by Government to control production or consumption of a good or service
Different situations in which the government may regulate the market:
Different trade-offs that the government needs to consider when regulating
Likely to be trade-offs between different objectives in regulation
Designing correct regulatory framework for a particular market needs to reflect particular features of the market and the areas of most concern
Benefits of regulation versus the costs
Regulation increases firms’ costs – could be passed on in form of higher prices
Administering regulation can result in higher costs to the taxpayer
In some cases – may not be proportionate to impose regulation
Strengthening incentives versus continuity of services
Possibility firms might fail can strengthen firms’ incentives to deliver value for consumers
But, if failure occurs – may negatively affect consumers if continuity of services can’t be guaranteed
Importance of continuity depends on good or service in question e.g. essential services like water and energy are more important
If continuity is important, further regulation of Government intervention may be required to address this trade-off, to ensure some degree of consumer protection if a Firm fails
• Pension Protection Fund is an example which provides compensation to pension scheme members if their employer becomes insolvent
Low prices versus incentives to invest and innovate
Prices can be regulated to ensure they are not too high
But regulating prices too tightly may not give firms sufficient incentives to invest and innovate
Likely to be concerning in sectors where potential for benefits from R&D is large, like information and communications technology or pharmaceuticals
Protecting consumers versus product innovation
Regulation required in some sectors to ensure products and services are of a minimum quality standard – E.g. compliance with safety requirements
In other sectors (financial) – may be limits on the type of products that can be sold to consumers, to avoid the risk of vulnerable consumers purchasing products that are not suitable for them
Benefits to one group of consumers at the expense of others
Regulation may benefit some groups of consumers but impose costs on others
An obligation to serve a particular group of consumers may increase firms’ costs – may be passed on in the form of higher prices to other consumers or in form of taxes – harm the taxpaye