Alevel Economics Chapter 19

Alevel Economics Chapter 19
: PURPOSE AND METHODS

OF GOVERNMENT
INTERVENTION
By Hugo
Learning objective
• Understand the purpose of government intervention, including

reference to market failure.
• Understand methods of intervention.
• Understand contexts in which governments may intervene.
Vocabulary list
• cap and trade schemes :schemes that set a limit on a

particular type of pollution, and then issue pollution permits to
the total of that limit, which can be bought and sold between
firms that pollute.
• trade pollution permit or pollution permit or pollution
credit :a permission issued, usually by a government, to allow
a fixed amount of pollution to be created; this permit can be
used by the owner or sold to another firm.
What is government again?
• The government is the central authority in a

country or region responsible for making and
implementing public policy, regulating
economic activity, providing public goods and
services, redistributing income, and
maintaining economic stability
Why would market fail
sometimes?
Market failure
• There is a variety of types of

market failure that include
externalities, provision of
public goods and
information failure.
• Governments can intervene in a
number of different ways to
correct market failure. Total
welfare will be increased if the
cost of an intervention is less
than the benefits gained from
the intervention
Indirect tax
• Indirect tax: a tax on expenditure.
• It is one of the ways the

government can fix market failure
• For example, if firms are polluting

too much, the government can
tax production to reduce pollution.
• But how much?

How much is enough?
• The level of the tax needs to be

set so that negative externalities
are eliminated and the marginal
social cost of production equals
the marginal social benefit.
• MSC line for tax will be behind

the MPC curve.
• ad valorem tax: tax on

percentage
On ad valorem tax
• The MPC and MSC lines move

further apart as output
increases. This shows that the
negative externality per unit
increases as output increases.
• It is then appropriate to impose
an ad valorem indirect tax
where the amount of tax paid in
money terms rises as price
rises.
On specific tax
• the MPC and MSC lines are

parallel. it is appropriate here to
impose a specific tax, like duty
on petrol in the UK. The amount
of tax per unit stays the same
as the price of the good
increases.
• A set amount of tax per unit

Disadvantage of indirect tax
• They may be difficult to target. So the tax may be too large or too small
to correct the market failure exactly. Partly, this may be down to information
failure on the part of government: it does not know the exact size of the
market failure or it may not know the impact a tax will have on the market.
• Governments may use indirect taxes to raise revenues as well as reduce
market failure. The two objectives can then conflict when decisions are
made about the size of the tax.
• Taxes are unpopular. In 2017, the state of Louisiana in the USA
abandoned a plan to raise tax on fuel because of political opposition. iy
claimed that the increase in tax revenue was needed to repair the road
system
Using subsidy to fix market failure
• There are positive externalities

in consumption from electric
vehicles. The private benefit to
the owner of the electric vehicle
is less than the benefit to
society of more
environmentally friendly
electric vehicles on the road.
• Then a government could
provide subsidies, for example,
for the purchase of more such
cars.
Other example
• Subsidies can be used where

there are positive externalities.
They can also be used to
correct information failure. The
government could subsidise the
provision of information to
those suffering from a lack of
information.
• For example, government

paying advertisement to spread
the use of vaccine.
Disadvantage of subsidy
• They may be difficult to target. As with taxes, the subsidy may be too large
or too small to correct the market failure exactly.
• There can be conflict with other policy objectives.
• Government can pay for subsidies but who in the end will pay?
• Citizens? More tax?
• Print more money? Inflation?
• Subsidies can be difficult to remove. Those who receive the subsidies
effectively receive an increase in their income. if the subsidy is lowered or
removed, they can lobby government to delay or abandon plans to change
the subsidy.
Other than
using money,
can
government
use another
way?
Maximum price
• Market failure can arise if consumers

cannot afford to buy basic necessities
such as food and housing.
• Food and housing can have positive

externality for society and we should
increase the consumption of these
goods.
• Imposing maximum prices for these
goods will make them more affordable.
• A problem with this policy is that if
prices are forced down it make goods
more affordable, then the quantity
supplied falls.
Maximum price
• Maximum prices often lead to

black markets. For example,
some of the goods bought at
price OF by consumers are
resold on the black market at a
higher price. Equally, producers
may sell directly onto the black
market to get higher prices.
• Another name for maximum

price is price ceiling.
Minimum price
• Some goods, such as cigarettes,

have significant negative
externalities in consumption.
• Governments may attempt to
correct the resulting market
failure by raising their price to a
level where marginal social cost
and marginal social benefit are
equal.
• However, this will create excess

supply.
Minimum price
Excess supply becomes a

problem if it is able to return to
the market. In the case of
cigarettes, minimum prices tend
to create black markets where
cigarettes are sold at less than
the minimum price.
In another word: price floor

Regulation
• Regulation is widely used to correct market failure.

• For example, regulation could be used to close information gaps.
• Airlines could be forced to reveal all the charges for an airline
ticket at the start of the booking process rather than at the end.
• Banks are forced to tell customers the rate of interest on a loan.
• Real estate must share what happened with the house before
• Let’s analyze some government regulations.

Carbon Tax in British Columbia,
Canada
• Greenhouse gas emissions are a

negative externality because they
contribute to climate change, which
has harmful effects on the environment
and human health. These costs are not
borne by the producers or consumers
of the fossil fuels causing the
emissions but by society at large.
• Government Action: To address this,

the government of British Columbia
implemented a carbon tax in 2008.
This tax is levied on the carbon content
of fossil fuels, effectively increasing the
cost of emitting greenhouse gases.
Problem?
• Increased Costs: The carbon tax raised the cost of fossil fuels,
which led to higher energy prices. This was particularly
burdensome for energy-intensive industries and lower-income
households, which spend a larger portion of their income on
energy.
• Public Opposition: The carbon tax faced resistance from some
segments of the public, especially in rural areas where driving
long distances is necessary and alternatives are limited. This
opposition can lead to political challenges, as seen in other
regions where similar taxes were proposed or implemented.
All regulations
have their
drawbacks,
you must
know how to
find it out.
Trade pollution permit
• Externalities caused by
pollution can be reduced
through the use of trade
pollution permits, a key
element of cap and trade
schemes.
So how does it actually work?
• assume that the government wishes to control emissions of

carbon.
• It has set a limit or cap on the amount of carbon to be emitted
over a period of time, for example, a year.
• This cap acts as the target for carbon emissions and is likely to be
lower than current levels of carbon emission.
• The government then allocates permits to emit carbon, the total
of which equals the cap. It could issue these, for example, by
giving them to firms that currently emit carbon.
So how does it actually work?
Part 2
• The permits are then tradable for

money between polluters.
• In the end, the total pollution will

decrease and it will be given to
the firms with the highest
willingness to pay.
• So what’s the advantages and

disadvantages?
Advantage of pollution permits
• The main advantage of trade

pollution permits over simple
regulation is that costs in the
industry and therefore to
society should be lower than
with regulation.
• Each firm in the industry will
consider whether it is possible
to reduce emissions and at
what cost.
Example:
• Assume that firm A, with just enough permits to meet its

emissions, can reduce emissions by 500 tonnes at a cost of
US$10 million.
• Firm B is a high polluter and needs 500 tonnes worth of permits
to meet regulations. It calculates that it would need to spend
US$25 million to cut emissions by this amount.
• If there was simple regulation, the anti-pollution costs to the
industry, and therefore to society, would be US$25 million. Firm
B would have to meet its pollution limit while there would be no
incentive for firm A to cut pollution.
However, if we can buy and sell
• With permits, firm A could sell 500 tonnes of permits to firm B.

The cost to society of then reducing pollution would only be
US$10 million, the cost that firm A would incur. it might cost
firm B more than $10 million to buy the permits. It would be
prepared to spend anything up to US$25 million to acquire
them.
• As long as Firm A sells less than 25 million, the society benefit
from Firm A not producing more while Firm B reach it’s
requirement.
Public good
• Characteristics:
• non-rivalry
• non-excludability
• Because of this, the company
rarely wants to provide public
good.
• It doesn’t make money!
• The result is market failure.
• But some goods are needed to
keep the society from running.
• Can you think of some example?
Types of public goods
Government’s role in supplying
public good
• Direct provision can have

disadvantages. it may lead to
inefficient production, particularly if
the government produces the good
itself.
• This is because employees of the
state, whether providing the good or
buying it in, may have no incentive
to cut costs to a minimum.
• It may also be inefficient because of
the wrong mix of goods it produces,
especially if the goods are provided
free of charge to taxpayers.
Provision on information
• Information failure occurs because one party to a

transaction does not have the information that is
available to make a decision.
• A government can step in to provide the information
itself. For example, it might run advertising campaigns to
deliver messages about not smoking. Or it might force
parties to a transaction to release information.
• Forcing cigarette manufacturers to put messages about
the dangers of smoking on cigarette packets is an
example.

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: PURPOSE AND METHODS

• Understand the purpose of government intervention, including

• cap and trade schemes :schemes that set a limit on a

• The government is the central authority in a

• There is a variety of types of

• It is one of the ways the

• For example, if firms are polluting

• But how much?

• The level of the tax needs to be

• MSC line for tax will be behind

• ad valorem tax: tax on

• The MPC and MSC lines move

• the MPC and MSC lines are

• A set amount of tax per unit

• There are positive externalities

• Subsidies can be used where

• For example, government

• Market failure can arise if consumers

• Food and housing can have positive

• Maximum prices often lead to

• Another name for maximum

• Some goods, such as cigarettes,

• However, this will create excess

Excess supply becomes a

In another word: price floor

• Regulation is widely used to correct market failure.

• Let’s analyze some government regulations.

• Greenhouse gas emissions are a

• Government Action: To address this,

• assume that the government wishes to control emissions of

• The permits are then tradable for

• In the end, the total pollution will

• So what’s the advantages and

• The main advantage of trade

• Assume that firm A, with just enough permits to meet its

• With permits, firm A could sell 500 tonnes of permits to firm B.

• Direct provision can have

• Information failure occurs because one party to a

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