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Government Regulation Buffer Stock Schemes
Price Elasticity
Reduce price
of Demand
fluctuations of
Price Elasticity
a commodity.
of Supply Determinants
– Availability of
Determinants substitutes
– If the good is a
– Level of spare luxury or necessity
capacity Elasticity good.
– State of the – If it’s an addictive
economy good
– Ease of entry into – Time period = short


Cross Elasticity Income Elasticity % CHANGE IN

of Demand of Demand INCOME

– Substitutes= rise in price in
coffee, increased demand for
– Normal good= when income
% CHANGE IN PRICE FOR increases, demand increase
B – Complementary = fall in – Inferior good = when
income increases, quantity
price of fuel, increase demand
for cars
Grant provided by the Subsidies Tradable Pollution Permits
government to encourage
Advantages of Regulations
production and
– Simple to understand. Eg age – 2005 – European Commissions= this attempts to limit
consumption. Goods
restrictions on that
alcohol. greenhouse gas emissions from heavy industry.
–have high external
Its possible to fine companies who – Each year they give out carbon dioxide permits. These
don’t apply to the regulation
benefits permits are tradable so firms can buy and sell them.
– Consumer protection laws may help
reduce asymmetric information

How to correct market failure?

Disadvantages of Regulations
– Expensive to monitor firms actions
– Extras cost to firms – ie installing
pollution monitoring system.
– Hard to obtain a value for pollution
– Regulations prevents the price
mechanism from working, it over
rules it.
Advantages of Buffer Stock
– Reduce price fluctuations stabilize income.
– Greater certainty in the market, leads to more
– Helps ensure provision commodities even in

Disadvantages of Buffer Stock

– If several years of good harvest then puts pressure
on government to buy up stock – expensive
– Storage costs, security
– The good may be perishable so would not last in
– Years of bad harvest would lead it to low stock so
price would drastically increase.
Taxes levied on the – Indirect taxation
Indirect taxation
expenditure of goods.
– Subsidies
The government
– Pollution permits
imposes tax on goods
with big external costs
– Property rights
– Regulation
Advantages of Pollution Permits
– Buffer stocks
– Specific market
– Pollution permits can reduce
– Minimum over
time by cutting emission allocations
– Firms have an incentive to invest in
clean technology
– Production costs will increase for
How to correct market failure?
firms who exceed their permits.
– Governments can sell their permits
for extra cash.

Disadvantages of Pollution Permits

– The commission may give too many
credits thus little incentive to
reduce pollution.
Advantages of Subsidies Disadvantages of Subsidies – Disputes between companies as they
– Reduce air pollution – Opportunity cost to think they should receive larger
– Uses more renewable energy government subsidies = cut permits.
to promote sustained gov. spending – Firms may make higher costs to pay
economic growth. – Firms may become for buying more permits.
– Rate of consumption of non- inefficient as rely on – EU firms may avoid finding better
renewable resources is subsidies technology and get cheaper
schemes in developing countries.
– Just applies in the EU needs to be
effective all over the world.
Labour Immobility Imperfect Market Knowledge

Symmetric Information
Frictional Unemployment
– Normal – while people search for jobs and fill – Where consumers and producers have
them. perfect and equal market information on
a good. This leads to an efficient allocation of
– Free market equilibrium is Pe and Qe resources.
– Socially optimum equilibrium is P1
and Q1
– ZY shows external cost
– By placing tax equal to external cost
it internalizes the pollution
– Consumer tax top = YP1PeT

How to correct market failur

Disadvantages of indirect tax Advantages of indirect tax

– Tax increases cost of production – Both producers and consumers
for firms so make them less pay
competitive. – They help internalize the
– Firms may re locate to places with external costs while maintaining
less tax regulations consumer choice.
– Encourage development of illegal – Level of pollution decreased as
markets. output has decreased and price
– The tax gained may not be used to increased.
help environment or consumers.
Triangle of Welfare Loss Negative Externalities
– External Costs = occurs in production or consumption of a
Eg chemical firm polluting a river. This is an external cost to water
Structural Unemployment –
suppliers as they would have to purify the water.
– Due to a mismatch of skills and location
– Private Costs = costs
Asymmetric Information
internal to the firm. Cost of workers, rent,
between job seekers and providers
Types of Market Failure
raw materials, and machinery costs.
Geographical Immobility – Social Costs = is external
– Reality and private
they both costs added and
have imperfect together:
(Knowledge, Immobility)unequal knowledge upon which they make
– Obstacles which prevent labour from
moving from one area to another: their decisions and this could lead to
– Family, finance, knowledge inefficient allocation of resources
– Producers might know more about a good
Occupational Immobility /service. E.g. second hand salesman would
– Prevent labour from changing type of know more about the history of the car then
occupation the consumer.
– The consumer if purchasing a insurance
policy could hide information of a risky

Bad Harvest Unstable Commodity Markets Good Harvest

Commodities = Raw materials used in
the production of goods

– Good weather increases supply

to S1, cause prices to fall.
– Supply in inelastic
– Total revenue falls
– A necessity good

– Bad weather decreases

supply and so prices rise
– Total revenue increases
Public Goods

Market Failure – Externalities

– Non Excludable
– Non Rivalry
When the price – Public goods
mechanism causes – Imperfect market
– Once a public good has been provided,
inefficient allocation of
the cost of supplying it to an extra knowledge
consumer is zero resources and leads to
net welfare loss – Labour immobility
– National defense, street lighting.
– Unstable commodity
Types of Market Failure

Positive Externalities
Triangle of Welfare Gain
– External benefits = recycling waste materials reduces
amount of waste disposal at landfill sites as well as re-using
materials for production.
– Private Benefits= ie the revenue that a firms receive from
selling a good/service
– Social Benefits = adding private and external benefits
Balance in market, with no
Consumer Surplus
Extra amount of tendency for output or price to
money consumers are change
willing to pay above
what they actually

The Under Provision of Public Goods

– The free rider problem = It is not
possible for firms to withhold the good
from those customers who refused to
pay for it. E.g. street lighting – people Why do some Markets Fail?
refuse to pay as they know someone
else will.
– The valuation problem = It’s difficult
to measure the value obtained by
consumers of public goods so hard to
put on a market price.

Government Provision of Public

– In a mixed economy governments Government Failure
provide public goods to try and correct Poor Political
This occurs when Information, interference
market failure.
– Raises funds from general taxation government intervention politicians may e.g. politicians may
– Merit good – vaccine less than the to overcome market have poor take the short term
social optimum position failure fails. information about new long term
the type of
Lack Of
incentives: There
Reasons Why? is no profit motive
working in the
public sector this
Supply for Labour Demand for Labour

Derived Demand = where demand for one

Quality, quantity of labour hours offered
Consumer + good or service occurs as a result of demand
for work over a given time period for another.

Producer Surplus Way price responds to

Extra amount of money changes in demand or
paid to producers above
What Determines the Price of a Good in a Market?
supply for a product
what they are willing to
so new equilibrium is

Mechanism Functions

Rationing Device Incentive Device

If resources are Rising prices
scarce, the price encourages firms
mechanism allocates to produce more.
them to those who They can also
are prepared to pay cover the extra
the most for them. costs as well.
Signalling Device
Price mechanism indicates changes in conditions of
demand or supply.
Eg demand increase so firm supplies more. So more
resources are allocated to production
Levied directly on
an individual or Grant usually
organisation provided by the
Levied on purchase Fall in price
of goods / services government to
Revetments at Easington Determinants
increase supply. for demand for labour
Determinants for supply for labour
○ Protect the gas terminal – Demand for final labour = An increase in
– Net migration = UK received boost in
○ Large granite boulders demand for good/service is likely to cause
economy from immigration mainly from
stacked a increase in demand for labour. Profit
Eastern Europe.up
○ Absorbs energy incentive, as prices increase because of
– The wage rate = increase in wage rate
○ Very expensive
will encourage more people to over
– The wage rate = a fall in wage rate
○ Sometimes
themselves unacctractive
for work. Encourages people to
work for longer. What Determines Wage Rate?means labour becomes more affordable so
firms will demand more labour.
– Income tax = reduction in income tax
– Price of other factor inputs = increase
means people have more disposable
price of capital encourage firms to employ
income and have an incentive to work.
more labour and cut back on machinery.
Many people will substitute leisure for
This is because labour and capital may be
substitutes in the production process.
– Trade unions = trade unions act to
– Productivity of labour = an increase in
increase wage rate and improve working
output per worker may lead to higher
conditions. This may encourage increase in
revenue and profits, encouraging firms to
supply of labour.
employ more people.
– Government regulations = national
– Government employment regulations =
minimum wage help increase supply.
the fewer the regulations, the greater
demand for labour. Eg national minimum
wage decreases labour
. Maximum potential level of
Positive = Facts,
output for 2 goods/services Shift Outward
value free. Scientific
that an economy can achieve
Direct Tax Due to:
when all resources are fully Quality/quantity or
Normative = Value employed. resources
Subsidy is often paid
judgements. Tax Education/grants
directly to producers, but
New Technology
Should, ought,
Tax Subsidie also reaches consumers as
better, fair Positive / Normative output has increased
Production Possibility Shift Inward
Ad Valorem tax: Statements
Specific tax:
Charged as a % of
Fixed amount per
a Nature
Change of
Price is Frontiers
Explained Due to:
the price of a unit of good. War
good. Natural disasters
Opportunity Cost

Division of Labour
The value of the next Advantages:
best alternative – Be highly skilled in
forgone. that area
Form of specialisation – No time wasted
= individuals – Less time is required
Free-market Free-market / concentrate on to train workers
– More choice of jobs
Consumer taxMixed
on top! Economies production of a
Disadvantages for workers
Decided by the particular good.
Thailand – Higher output per
price mechanism: – Repetition = boredom, high
Centrally Mixed turnover of staff
– Reduces cost of
– What Decisions are made
Planned – Structural unemployment, easy to
– How partly by private output
replace worker with robots.
– Who Government UK sector, partly by
– Specialization creates
makes all France government
interdependence in production. If
decisions Germany
one section goes on strike, the