Government Policies To Achieve Efficient Resources Allocation And Correct Market Failure (Copy)
8.1.1 Application and Effectiveness of Measures to Tackle Different Forms of Market Failure
1. Specific and Ad Valorem Indirect Taxes
- Specific Tax:
- Fixed amount per unit sold (e.g., $1 per pack of cigarettes).
- Shifts supply curve vertically upwards by fixed amount.
- Ad Valorem Tax:
- Percentage of price (e.g., 10% VAT).
- Supply curve shifts upwards, increasing with price.
Effectiveness:
- Discourage negative externalities by increasing price, reducing quantity demanded.
- May cause deadweight welfare loss if set too high.
- Regressive impact if poor spend more proportionally.
2. Subsidies
- Payments by government to producers or consumers to encourage production/consumption.
- Shifts supply curve downward or demand curve upward.
Effectiveness:
- Encourages positive externalities (e.g., renewable energy).
- Risk of overproduction, budget strain, inefficiencies.
3. Price Controls
- Price Ceiling: Maximum price set below equilibrium to protect consumers (e.g., rent controls).
- Price Floor: Minimum price set above equilibrium (e.g., minimum wage).
Effectiveness:
- Can lead to shortages (ceiling) or surpluses (floor).
- May cause black markets or unemployment.
4. Production Quotas
- Limits on quantity produced to control supply.
- Used to restrict output and raise prices (e.g., agricultural quotas).
Effectiveness:
- Helps manage externalities or stabilize markets.
- Can encourage inefficiency and smuggling.
5. Prohibitions and Licences
- Prohibitions: Bans on harmful goods (e.g., asbestos).
- Licences: Limit production or access (e.g., taxi licences).
Effectiveness:
- Reduce harmful consumption or control market size.
- Can create black markets and reduce consumer choice.
6. Regulation and Deregulation
- Regulation: Rules to control firm behaviour (e.g., pollution limits).
- Deregulation: Removing regulations to increase competition.
Effectiveness:
- Regulation protects consumers and environment but can increase costs.
- Deregulation fosters innovation and lowers prices but risks abuse.
7. Direct Provision
- Government supplies goods/services directly (e.g., healthcare, education).
Effectiveness:
- Ensures provision of public goods and merit goods.
- May suffer inefficiency and bureaucratic costs.
8. Pollution Permits
- Tradable permits allowing firms to pollute up to a limit.
- Creates a market for pollution rights (cap-and-trade).
Effectiveness:
- Provides incentives to reduce pollution efficiently.
- Requires monitoring and enforcement.
9. Property Rights
- Clearly defined ownership and enforcement of rights over resources.
Effectiveness:
- Prevents overuse of common resources.
- Difficult to enforce in some contexts.
10. Nationalisation and Privatisation
- Nationalisation: Government takes control of industries.
- Privatisation: Transfer of state-owned firms to private sector.
Effectiveness:
- Nationalisation ensures public interest but may reduce efficiency.
- Privatisation can improve efficiency but risk monopolies.
11. Provision of Information
- Government provides information to reduce asymmetric information (e.g., food labelling).
Effectiveness:
- Improves consumer decisions and market outcomes.
- Information may still be ignored or misunderstood.
12. Behavioural Insights and ‘Nudge’ Theory
- Using psychology to influence choices without restricting freedom.
- Examples: default options for pensions, calorie labelling.
Effectiveness:
- Cost-effective and subtle way to improve decision-making.
- Ethical concerns about manipulation.
8.1.2 Government Failure in Microeconomic Intervention
Definition of Government Failure
- Occurs when government intervention worsens market outcomes instead of improving them.
- Leads to inefficient resource allocation and welfare loss.
Causes of Government Failure
- Information failure: Poor or incomplete data.
- Regulatory capture: Firms influence regulators for own benefit.
- Unintended consequences: Policies have adverse side effects.
- Costly bureaucracy: High administrative costs reduce efficiency.
- Political self-interest: Decisions driven by politics, not economics.
- Inflexibility: Slow to adapt to changing conditions.
Consequences of Government Failure
- Waste of resources.
- Distortion of prices and signals.
- Reduced incentives for firms and consumers.
- Increased corruption and inefficiency.
Diagrams
Diagram 1: Effect of Indirect Tax on Negative Externality
Price
↑
| MSC (MSC = MPC + Tax)
| /
| /
| /
| /
| /
| / MPC
|/___________ Demand
|
|
|_______________________→ Quantity
- Tax shifts MPC upward to MSC.
- Output reduced from Qm to Q*.
Diagram 2: Effect of Subsidy on Positive Externality
Price
↑
| MSB (MSB = MPB + Subsidy)
| /
| /
| /
| /
| /
| / MPB
|__/________ Supply
|
|
|________________________→ Quantity
- Subsidy shifts MPB upward to MSB.
- Output increased from Qm to Q*.
Diagram 3: Pollution Permits Market
Price of Permits
↑
| Supply of Permits (fixed)
| ________
| /
| /
|_______/___________________→ Quantity of Permits
- Fixed number of permits creates scarcity.
- Firms trade permits to minimize costs.
Diagram 4: Government Failure
Efficient Allocation
↑
| Market Failure (Welfare Loss)
| /
| /
|____________/___________ Government Failure (Even Greater Loss)
|____________________________→ Time