Government Intervention Latest'

Platinum Business Academy
No 106, S D S Jayasingha Mawatha,

Kohuwala, Sri Lanka Edexcel Unit1 (IAL)
Government Intervention
The government may choose to intervene in the price mechanism largely on the
grounds of wanting to change the allocation of resources and achieve what they
perceive to be an improvement in economic and social welfare. All governments
of every political persuasion intervene in the economy to influence the allocation
of scarce resources among competing uses
The main reasons for policy intervention are:

• To correct for market failure
• To achieve a more equitable distribution of income and wealth
• To ensure resources are allocated efficiently
There are 4 main methods of government intervention. The method selected
depends upon the one of the above given reason.
1. Government Legislation and Regulation
Legal and other methods that are used to control the quality and quantity of
goods and services consumed and produced.
Parliament can pass laws that for example prohibit the sale of cigarettes to
children, or ban smoking in the workplace. The laws of competition policy act
against examples of price-fixing cartels or other forms of anti-competitive
behaviour by firms within markets. Employment laws may offer some legal
protection for workers by setting maximum working hours or by providing a
price-floor in the labour market through the setting of a minimum wage.
2. Financial intervention
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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business &
Management + Business & Human Resources (UK)
These are methods used to influence production and price of commodities’
(a) Indirect taxes can be used to raise the price of de-merit goods and products
with negative externalities designed to increase the opportunity cost of
consumption and thereby reduce consumer demand towards a socially optimal
level
(b) Subsidies to consumers will lower the price of merit goods. They are
designed to boost consumption and output of products with positive
externalities – remember that a subsidy causes an increase in market supply
and leads to a lower equilibrium price
(c) Tax relief: The government may offer financial assistance such as tax
credits for business investment in research and development. Or a reduction
in corporation tax (a tax on company profits) designed to promote new
capital investment and extra employment
(d) Changes to taxation and welfare payments can be used to influence the
overall distribution of income and wealth – for example higher direct tax
rates on rich households or an increase in the value of welfare benefits for
the poor to make the tax and benefit system more progressive
3. State production
Goods which are not provided by the private sector is provided by state.
Because of privatization, the state-owned sector of the economy is much
smaller than it was twenty years ago. The main state-owned businesses in the
UK are the Royal Mail and Network Rail.
State funding can also be used to provide merit goods and services and public
goods directly to the population e.g. the government pays private sector firms
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Wasim Imtiasz
to carry out operations for NHS patients to reduce waiting lists or it pays
private businesses to operate prisons and maintain our road network.
4. Income and transfer
Used by the government to redistribute income from one group to another in
the society. This is done to create equity. Ex – progressive taxation, pension and
unemployment benefit.
5. Intervention designed to close the information gap
Often market failure results from consumers suffering from a lack of
information about the costs and benefits of the products available in the
market place. Government action can have a role in improving information to help
consumers and producers value the ‘true’ cost and/or benefit of a good or
service. Examples might include:
• Compulsory labelling on cigarette packages with health warnings to reduce

smoking
• Improved nutritional information on foods to counter the risks of growing
obesity
• Anti-speeding television advertising to reduce road accidents and advertising
campaigns to raise awareness of the risks of drink-driving.
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Wasim Imtiasz
Negative externality
1. Charging of indirect tax
Why?
If the government charges a tax equivalent to negative externality, private cost
would increase and would be the same as social cost. This process is identified
as ‘internalising the externality’ since production cost is high
production/consumption reduces to social optimum level of output.
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What is the Problem?
2. Extending property rights
Externalities often arises when ownership is not fully allocated (property right)
NOBODY OWNS THE ATMOSPHERE
By assessing property rights we give the owner the right to charge
compensation
Ex –
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Wasim Imtiasz
Ex –
When compensation is charged we are internalising the externality (making part
of the private cost) this will reduce production and thereby negative
externality.
3. Regulations
Is the use of legal intervention to force consumers and producers to behave in a
particular way? Regulations are used frequently to overcome market failure
caused by externality Ex – Pollution
Government may set limits with regard to the level of pollution and then
regulate and inspect to see whether the restrictions are enforced. It ensures
this by charging fines if it’s not adhered
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Wasim Imtiasz
4. Tradable pollution permits
It is a method of direct control. Government sets limits on the amount of
pollution permitted and then allocates permits to individual firms or polluters.
These permits are tradable among polluters
The advantage of permits over regulations is that cost to industry and
therefore to society is lower with regulations.
Positive Externality
1. Education and training
2. Financial intervention
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3. Advertising
Through positive advertising government can persuade consumers to increase
their consumption and thus lead to a shift of MPB to the right i.e. increase in
demand. If the MPB curve shifts enough, it will coincide with MSB and Q* will
be produced and consumed.
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Government failure
Government failure occurs when the government intervention fails to allocate
the resources effectively resulting in a loss of economic welfare.
When the government intervenes to correct market failure and when it leads a
net loss of economic welfare, it is identified as market failure.
Net social cost > Net social benefit
Distortion of price signals
When government intervention distorts the equilibrium it is identified as
market distortion.
• Tariff
• Minimum wage
• Subsidies
Unintended consequences
1. “Shoot, Shovel, and Shut Up”
The Endangered Species Act and other laws restrict how landowners can use their property if
it is discovered that their actions may adversely affect vulnerable wildlife. Besides the
injustice of violating property rights, this regulation produces perverse results.
Imagine a landowner in the Midwest who had plans to sell to an outside developer who
wanted to build a shopping mall. One morning, a few days before closing the deal, the man is
sipping coffee and looking off his back porch into the woods. He suddenly sees a woodpecker
that he recognizes as a protected species. What will the man do, if he follows pecuniary
incentives? Is he going to call up federal bureaucrats and tell them the good news?
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Wasim Imtiasz
No. The man will probably go get his gun and shovel and never speak of this incident to
anyone.
2. Seat Belt Legislation Kills
In the typical debate over seat belt mandates — in which drivers can be heavily fined if
caught driving without buckling up — advocates of liberty tend to stress individuals’ “right to
be stupid” while others claim that public safety trumps absolute freedom. Ideology aside, do
such laws make us safer?
Economist Sam Peltzman looked at the evidence after some states enacted seat belt
legislation, while others did not. He found that drivers did buckle up more frequently because
of the government penalties but that traffic fatalities were roughly unchanged.
Because seat belts made people feel safer, they drove just a little more recklessly.
True, the probability of dying in a car crash went down, ifyou were in a crash, because
wearing a seat belt definitely helps you survive a typical accident. However, the states that
passed the seat belt legislation saw an increase in rates of traffic accidents. Because people
felt safer, they drove just a little more recklessly. No individual driver wakes up and says,
“I’m going to get in a fender bender today,” but with millions of people driving hours per
day, 365 days per year, we will definitely see more accidents in the aggregate if people are
even slightly more aggressive on the margin.
Peltzman found that total fatalities were about the same. The death rate for motorists crept
down, but this was offset by a higher death rate among pedestrians and cyclists hit by cars.
Some groups obviously did not benefit from the higher prevalence of seat belt usage.
3. smoking ban will increase the use of heaters in cold countries
Excessive administrative cost
Government intervention can prove costly to administer and enforce. The
estimated social benefits of a particular policy might be largely swamped by the
administrative costs of introducing it.
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Wasim Imtiasz
Information gaps
• Indirect tax diagram
• Cost benefit analysis
Often a government will choose to go ahead with a project or policy without
having the full amount of information required for a proper cost-benefit
analysis. The result can be misguided policies and damaging long-term
consequences.
Conflicting objectives
• Opportunity cost
• Scholarship exams
Regulatory capture
This is when the industries under the control of a regulatory body (i.e. a
government agency) appear to operate in favour of the vested interest of
producers rather can consumers
Political interference Decisions made for short-term political gain – rather than
sound economics, e.g. keep on unproductive workers. e.g. politicians may take the
short-term view rather than considering the long-term effects
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Wasim Imtiasz
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Platinum Business Academy

No 106, S D S Jayasingha Mawatha,

perceive to be an improvement in economic and social welfare. All governments

of every political persuasion intervene in the economy to influence the allocation

of scarce resources among competing uses

The main reasons for policy intervention are:

• To achieve a more equitable distribution of income and wealth

• To ensure resources are allocated efficiently

There are 4 main methods of government intervention. The method selected

depends upon the one of the above given reason.

1. Government Legislation and Regulation

goods and services consumed and produced.

against examples of price-fixing cartels or other forms of anti-competitive

protection for workers by setting maximum working hours or by providing a

price-floor in the labour market through the setting of a minimum wage.

with negative externalities designed to increase the opportunity cost of

consumption and thereby reduce consumer demand towards a socially optimal

designed to boost consumption and output of products with positive

externalities – remember that a subsidy causes an increase in market supply

and leads to a lower equilibrium price

credits for business investment in research and development. Or a reduction

in corporation tax (a tax on company profits) designed to promote new

capital investment and extra employment

rates on rich households or an increase in the value of welfare benefits for

Because of privatization, the state-owned sector of the economy is much

UK are the Royal Mail and Network Rail.

private businesses to operate prisons and maintain our road network.

4. Income and transfer

Used by the government to redistribute income from one group to another in

5. Intervention designed to close the information gap

Often market failure results from consumers suffering from a lack of

service. Examples might include:

• Compulsory labelling on cigarette packages with health warnings to reduce

If the government charges a tax equivalent to negative externality, private cost

as ‘internalising the externality’ since production cost is high

production/consumption reduces to social optimum level of output.

2. Extending property rights

NOBODY OWNS THE ATMOSPHERE

By assessing property rights we give the owner the right to charge

When compensation is charged we are internalising the externality (making part

Is the use of legal intervention to force consumers and producers to behave in a

particular way? Regulations are used frequently to overcome market failure

caused by externality Ex – Pollution

this by charging fines if it’s not adhered

It is a method of direct control. Government sets limits on the amount of

pollution permitted and then allocates permits to individual firms or polluters.

These permits are tradable among polluters

The advantage of permits over regulations is that cost to industry and

therefore to society is lower with regulations.

Through positive advertising government can persuade consumers to increase

be produced and consumed.

the resources effectively resulting in a loss of economic welfare.

net loss of economic welfare, it is identified as market failure.

Net social cost > Net social benefit

Distortion of price signals

When government intervention distorts the equilibrium it is identified as

1. “Shoot, Shovel, and Shut Up”

2. Seat Belt Legislation Kills

3. smoking ban will increase the use of heaters in cold countries

Excessive administrative cost

Government intervention can prove costly to administer and enforce. The

estimated social benefits of a particular policy might be largely swamped by the