Government Intervention in the Price System. A. Market Failure (Define and List) a. An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers. This is a direct result of a lack of certain economically ideal factors, which prevents equilibrium. b. Examples of market failure i. Where there are externalities present in a market ii. Where merit goods have to be provided because the market will fail to provide them iii. Where public goods are provided by the government, again because the free market will fail to do so B. Externalities (Define and include private and social costs) a. A consequence of an economic activity that is experienced by unrelated third parties. An externality can be either positive or negative. b. Private cost i. Those costs involved in an action that accrue to the decision maker c. Social costs i. Are all of the related costs associated with that action C. Negative Externalities (Define and include private and social costs) a. An external cost i. A private and social costs are not always equal ii. This is what causes externalities to exist in an economy iii. The social costs exceed the private costs of a decision D. Positive Externalities (Define and include private and social benefits) a. Private and social benefits i. The social benefits are all of the benefits that accrue from that decision ii. The private benefits are those that accrue solely to the decision maker iii. These are not always equal b. An external benefit i. The social benefits of a decision may exceed the private benefits E. The Problem Created by Externalities a. They will lead to an inappropriate amount of the product involved being produced: the free market will lead either to too much or too little production b. Because the social cost is different from the private cost, the price will be at a different price than the actual equilibrium and the amount of money to rectify the negative externality will be large c. Social cost vs private cost leads to a problem with the supply line d. Social benefit vs private benefit leads to a problem with the demand line

Which costs and benefits should be included ii. Merit goods . The Framework of Cost-Benefit Analysis (What are the four stages? What are the difficulties?) a. there are problems establishing external costs and benefits 2. The final stage 1. It seeks to include all of the costs and benefits. these are often controversial and not easy to define in a discrete way and have the added difficulty that it is not always possible to draw a physical and geographical cut off ii. Merit goods. Spillover Effects i. Those not involved in the project are effected d. sometimes of a very crude nature. Attempts to quantify the opportunity cost to society of the various possible outcomes or sources of action e. often a monetary value has to be placed for something at which there is not market value 3. The second stage involves putting a monetary value on the various costs and benefits 1. The production of a new development may cause the surrounding community to be polluted ii. The first stage is to identify all of the relevant costs and benefits arising out of any particular project 1. de-merit goods and information failures (Define each and give examples) a. is where the results of the earlier stages are drawn together so that the outcome can be presented in a clear manner in order to aid decision making b.F. The Cost-Benefit Approach (How is this used to solve the problem? How does it differ from private sector methods of appraisal?) a. in particular where there are substantial costs and benefits which fall upon people and communities who have no direct connection with the project c. The stages i. to estimate costs and benefits over many years iv. Differs from the private sector in the following ways i. Identifies various causes and consequences of market failure b. The third stage applies in situations where projects have longer-term implications which stretch well into the future 1. How to put monetary values on them H. However. The difficulties i. employ statistical forecasting techniques. not just the private ones ii. Has to impute shadow prices on costs and benefits where no market price is available G. A human life costs how much? iii. Major projects may produce important and controversial side effects. This is straightforward 2.

Merit Goods 1. good for a person regardless of what that individual may believe. This works as long as the doctor does not give us deliberately incorrect information 1. mentally harmful (gambling). A different type of good from a merit or demerit that may cause the market to fail b. c. e. De-Merit goods i. f. Paternalism 1. or is not. We would proceed to make an undesirable choice about possible treatment 2. Value Judgments 1. or morally harmful (prostitution). if a society is able to say to consumers what is good and bad for them. these taxes are frequently known as sin taxes. We go to the doctor to gain the necessary information and make a decision based upon the information we are given ii. Information failures i. This will cause a misallocation of resources I. A demerit good can be physically harmful (cigarettes). demerit goods are subject to additional taxes in an effort to reduce consumption. A result of merit and demerit goods ii. (Define and explain the characteristics required) a. Public Goods. It must be non-excludable 1. iii. d. It is acceptable for us to say that society can judge what is. because they would be under-provided if left to the market forces or private enterprise. it must be provided to all consumers . The characteristics i. This makes society be able to decide what is a merit and an demerit good The Problems i. Goods or services (such as education and vaccination) provided free for the benefit of the entire society by a government. Demerit goods 1. Their existence will cause an inappropriate amount of the products concerned to be produced ii. In many cases. then we are accepting that society knows best and has some right to make such judgments ii. A good which is considered unhealthy or damaging in some way. Either they don’t have the right information or lack some relevant information Value Judgments and paternalism i.b. Consumers do not perceive quite how good or bad a particular product is for them iii. i. will be over produced in a free market The Health Care Market i. will be under produced in a free market iii.

coal mining and railway industries are owned and managed entirely by the state in many countries . the free market has no mechanism for guaranteeing its production iii. Justification is usually market failure or the desire to achieve a fair or equitable distribution of resources in the economy b. Influence production. Concerned with ensuring that all members of society have fair access to goods and services d. Used to control the quality and quantity of goods and services that are produced and consumed ii. May regulate the sale of certain drugs by making them only available on prescription from a qualified doctor iii. Financial Intervention i. It does not necessarily mean it has to produce the product too c. Tax instruments may also vary iv. The Problem i. Although there is consumer demand. (Why should the government intervene? What are the two justifications?) a. Government intervention. the use of it must not diminish the benefit for others to use the good c. Industries such as the electricity. Market Failure i. The market may fail to produce them at all ii. incomes or the distribution of wealth in an economy iii. prices of commodities. Also called nationalized industries ii.ii. Regulation i. When governments attempt to achieve this aim it must be recognized that there is also the possibility that they will fail and create rather than remove distortions K. Methods of government intervention. Once a consumer has purchased the product. Free Riding problem 1. It must be non-rival 1. May not only apply to the quantity and quality of goods and services sold but may also refer to the prices b. all other consumers cannot be prevented from benefiting from that product 2. For example. Existence of such goods may mean that scarce resources are not used in a way that would be desirable J. A lighthouse iv. State production i. Governments also provide the finance that is needed to produce a good or service 1. Examples such as taxes and subsidies ii. Equitable distribution i. Occurs when markets do not allocate resources efficiently c. (List and explain the four methods) a.

and cooking oil b. Governments use legislation to enforce maximum prices for: a. Income and other transfers i. Considerable debate over which is the best method of government intervention iv. Caused by external benefits or positive externalities 2. The government might intervene by setting standards which restrict the amount of pollution that can be legally dumped b. Methods of raising funds 1. The environment a. Externalities i. (Explain and use GRAPHS) a. The government takes a larger percentage of income in tax from the rich than the poor 3. Education and health care are good examples d. The impact of government intervention on markets. such as bread. May be used to cover the unexpected loss of income when a person is not working due to illness or unemployment L. Need to regulate and inspect the company to make sure that these restrictions are enforced ii. Financial intervention – Taxes 1. Rents in certain types of housing . Example: people in work to those who are retired ii. A tax would be imposed on the individual or firm that causes an externality 2. Called a progressive tax system b. Need to be financed by the government but they do not necessarily need to be produced by the government ii. Maximum price controls and price stabilization 1. Financial intervention – Subsidies 1.iii. Setting standards and regulation 1. The government will decide upon the optimal amount of defense expenditure and raise revenue through taxation to fund it 1. The problem is choosing the best way to raise the funds necessary iii. Tax individuals according their ability to pay tax 2. rice. Governments frequently use regulation to overcome market failures caused by externalities 2. The government intervenes and imposes a tax which is equal to the marginal external cost iii. Staple foodstuffs. Used by the government as a means of redistributing income or transferring income from one group in society to another group 1. Public goods i. The external costs are then internalized 3. Finding some goods produced by both the state and the private sector is also vary common 1.

it is a method of transferring income. gas. prices can be stabilized at a predetermined level Cost-Benefit analysis – a technique for assessing the desirability of a particular project. The most likely way is by means of queuing Price stabilization policies. Services provided by utilities. Negative externality . but may also mean assets owned by lower levels of government. 3. there exists another conceivable outcome where market participants' overall gains from that outcome would outweigh their losses (even if some participants lose under the new arrangement).lso spelled nationalisation. such as welfare to persons. Merit goods – goods such as health care and education which have positive externalities associated with them and where there is likely to be under consumption without government intervention Nationalized industry . c. 5. is the process of taking an industry or assets into the public ownership of a national government or state. Market failure . Transport fares where a subsidy is being paid A price ceiling production is not sufficient to satisfy everyone who wishes to buy the product a.A negative externality occurs when an individual or firm making a decision does not have to pay the full cost of the decision. by the decisions or actions which are taken by others Income transfer . then the cost to society is greater than the cost consumer is paying for it. taking into account all of the respective costs and benefits De-merit goods – any good that has negative externalities associated with it. That is. the available supply has to be allocated on some other basis b. being transferred to the public sector to be operated by or owned by the state. especially in agricultural markets. negatively or positively. and electricity companies d. .Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. such as municipalities. such as passive smoking or the excessive consumption of alcohol Externalities – a situation where a third party is affected. As price cannot rise. are designed to lessen the effects of unplanned fluctuations in supply A producer’s association or a government-backed marketing board regulates supply by releasing stocks on to the market in order to stabilize farm incomes By releasing buffer stocks at times of shortage or by purchasing excess stocks at times of surplus production. If a good has a negative externality. such as water. 4.[1] Nationalization usually refers to private assets.2.

refers to an attitude or a policy reminiscent of the hierarchic pattern of a family based on patriarchy.externalities of economic activity or processes upon those who are not directly involved in it. this time referring to a situation where as more people consume a give good. Public goods – goods which possess the combined characteristics of non-excludability and nonrivalry. Value judgment . Private benefits – the benefits which directly accrue to an individual consumer or firm Private costs – costs which are directly incurred by the owners of a firm or an individual carrying out a particular activity Progressive tax . Progressive" describes a distribution effect on income or expenditure.Non-excludable – a characteristic of public goods whereby it is impossible to stop all from benefiting from the consumption of that good Non-rival – another characteristic of a public good. or equivalently the marginal cost of strengthening the constraint. State production – See nationalization Subsidies – a payment made by government to producers or consumers to reduce the market price of a good or service Taxes .an assessment that reveals more about the values of the person making the assessment than about the reality of what is assessed . the benefit to those already consuming is no diminished Paternalism .is to impose a financial charge or other levy upon a taxpayer (an individual or legal entity) by a state or the functional equivalent of a state such that failure to pay is punishable by law. where the average tax rate is less than the marginal tax rate. referring to the way the rate progresses from low to high. the beauty of a homeowner's flower garden is a positive spillover effect upon neighbours.a tax by which the tax rate increases as the taxable base amount increases. Odours from a rendering plant are negative spillover effects upon its neighbours. Shadow price . Social benefits – the total benefits accruing to the community as a whole from a particular action Social costs – the total costs borne by the community as a whole from a particular action Spillover effects .the change in the objective value of the optimal solution of an optimization problem obtained by relaxing the constraint by one unit – it is the marginal utility of relaxing the constraint.

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