1.4.1 Government intervention in markets


    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

    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    In place in many European countries, India, Japan and South Korea – repealed in Australia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





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