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Study Notes

1.4.1 Government Intervention in Markets (Edexcel)


Last updated 19 Sept 2023

This study note for Edexcel covers Government Intervention in Markets

Here are structured study notes for A-level economics on the topics of government intervention with reference to market failure, including indirect taxation (ad valorem and specific), subsidies, maximum and minimum prices, as well as other methods of government intervention such as trade pollution permits, state provision of public goods, provision of information, and regulation, with real-world examples where applicable:

A) Purpose of Intervention with Reference to Market Failure

1. Indirect Taxation

a) Ad Valorem Taxation

  • Ad valorem taxes are taxes calculated as a percentage of the price of a good or service.
  • The purpose of imposing ad valorem taxes is to internalize external costs (negative externalities) or generate government revenue.

Example: In many countries, cigarettes are subject to ad valorem taxes to discourage smoking (negative externality) and raise revenue for healthcare programs.

b) Specific Taxation

  • Specific taxes are fixed amounts per unit of a good or service.
  • They are often used to target specific industries or products.
  • Specific taxes can also be imposed to address negative externalities or generate revenue.

Example: In the context of specific taxation, gasoline is often taxed at a fixed amount per gallon or liter to address environmental concerns (negative externality) and fund infrastructure projects.

2. Subsidies

  • Subsidies are financial assistance provided by the government to encourage the production or consumption of certain goods or services.
  • Subsidies aim to correct market failures by promoting the provision of public goods, correcting positive externalities, or supporting strategic industries.

Example: Agricultural subsidies are common worldwide to ensure a stable food supply, support farmers, and prevent market failures related to food scarcity.

3. Maximum and Minimum Prices

a) Maximum Prices (Price Ceilings)

  • Maximum prices are government-imposed limits on the price of a good or service.
  • They are typically set below the equilibrium price to protect consumers from high prices.

Example: Rent control policies in cities like New York and San Francisco impose maximum rents to make housing more affordable for low-income residents.

b) Minimum Prices (Price Floors)

  • Minimum prices are government-imposed limits on the price of a good or service.
  • They are typically set above the equilibrium price to support producers, ensuring they receive a fair income.

Example: The U.S. government sets a minimum price for milk to ensure that dairy farmers receive a reasonable income.

B) Other Methods of Government Intervention

1. Trade Pollution Permits

  • Tradeable pollution permits are a market-based approach to reducing pollution.
  • Governments allocate a limited number of permits to firms, allowing them to emit a certain amount of pollution.
  • Firms can buy and sell permits, creating incentives to reduce emissions efficiently.

Example: The European Union's Emissions Trading System (EU ETS) allows companies to trade carbon emissions permits, encouraging the reduction of greenhouse gas emissions.

2. State Provision of Public Goods

  • Governments provide public goods, which are non-excludable and non-rivalrous.
  • Public goods are typically funded through taxation.

Example: Public goods like national defense, street lighting, and public parks are provided by governments to benefit all citizens.

3. Provision of Information

  • Governments often provide information to consumers to ensure informed decision-making.
  • Information provision can improve market efficiency and protect consumers.

Example: Food labeling regulations require manufacturers to provide information about ingredients and nutritional content on food packaging, helping consumers make healthier choices.

4. Regulation

  • Regulation involves government rules and standards to ensure market participants follow specific guidelines.
  • It can address issues like safety, environmental protection, and consumer rights.

Example: Financial regulations such as the Dodd-Frank Act in the United States aim to safeguard the financial system from excessive risk-taking and promote transparency.

Understanding the purpose of government intervention in various contexts, along with the methods employed, is essential for analyzing the impact of government policies on markets and economic outcomes. These interventions are often designed to correct market failures, ensure fairness, and promote public welfare.

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