Government Intervention - Taxation (Microeconomics)

Another way the government can intervene to correct market failure is through taxation. Basically, the government will try to tax goods with lots of negative externalities to attempt to discourage consumers from buying them, thus lowering consumption and somewhat correcting the market failure.

The government has two forms of taxation at its disposal, these being direct and indirect.

1. Direct Taxes - These are taxes off the incomes of individuals and firms. So examples of these would be income tax and corporation tax. Direct taxes cannot be avoided.
2. Indirect Taxes - These are taxes charged locally on goods and services. Examples would be VAT (Value added tax) and council tax (Tax on your house).

The aim of the tax is to try to reduce the consumption of the good by raising the price. So, the tax shifts the supply curve leftwards, moving the equilibrium point to a higher price and lower quantity. The tax that is imposed should equal the value of the negative externality. The price rises and the price then takes into account the full cost of the negative externality, this is known as the polluter pays principle. Basically, the polluter is now paying for all the pollution caused. 

There are problems with taxation however. Firstly, the amount to tax is difficult to workout. As it is hard to estimate the exact cost of a negative externality it means it is difficult to tax the absolute correct amount, most of the time its either too much or too little. Price elasticity of demand comes into play too. A rise in price caused by the taxation may not cause a big enough fall in demand because the goods PED may be inelastic. This is another problem. 

That's all for this topic, next is 'Government Intervention - Subsidies'. Stay tuned. :-)

Government Intervention - Regulation (Microeconomics)

Government intervention is when the government intervenes in the market to attempt to correct the market failure. This post will be on a specific type of government intervention - regulation.

Regulation comes in three different forms, these being laws/legislation, price controls and control of monopoly powers.

Laws and legislation is pretty self explanatory, passing laws or introducing legislation as an attempt to fix the market failure. An example of this would be passing the law meaning you have to be 18 to purchase alcohol. Alcohol is a good with negative externalities, thus is causing market failure. So passing the law means that the consumption of alcohol is limited somewhat and the market failure should be lessened.

Price controls is also a fairly self explanatory form of government regulation. It involves setting a minimum or maximum price for the good to affect the consumption. An example is the minimum wage, that is classed as a minimum price. This reduces the consumption of low paid workers, and corrects that market failure to a certain extent.

Finally, control of monopoly powers. This is the government intervening in a market where a monopoly exist to try and stop consumers being ripped off so to speak. In a monopoly market, one firm/business/individual has a large majority of that market, meaning they are pretty much in control and can set prices to whatever level they like whilst offering a poor service and still receive customers. Controlling these monopoly powers means the government will get involved to limit how much power the monopoly business has to protect the consumer, thus correcting the market failure.

That's about it, but ill list a few more examples of goods/services that have regulations imposed on them.

• Tobacco - Required to be 18 to buy it, shops need a license to sell it.
• Education - Law makes it compulsory. Not relevant anymore, but there used to be price controls with the maximum tuition fees.
• Driving - Law to wear a seatbelt.

Thanks for reading, up next is government intervention - Taxation!

Public Goods (Microeconomics)

A public good is a good that, as the name suggests, is consumed by the public as a whole therefore it is almost impossible to charge people for using them. Because of this, they have to be provided by the government using tax revenue rather than being privately supplied. If left to the free-market, most public goods would not be supplied, despite the benefits they give to people who consume them. An example of a public good would be street lights.

For a good to be classed as a public good it must fit into two categories, these being:

• Non excludable - This means that individuals cannot be excluded from consuming the good. Using the street lights example, it's virtually impossible to stop people consuming them once they have been provided, thus they can be classed as non-excludable.
• Non rival - This means that consumption by one individual does not affect the consumption of others. With street lights, if one person is using the light it isnt stopping others using it as well, thus they are non rival as well. 

If a good has both of these characteristics then it can be seen as a pure public good. If a good fits into one category, but not the other then it is said to be a quasi-public good. So, if a good is non excludable, but not non rival it would be a quasi public good. An example could be a beach. There's no way of stopping someone coming and sitting on the beach, therefore it is non excludable. However, if hundreds of people swarm to the beach and leave litter the consumption of that good is affecting other peoples consumption, so the good is rival. A beach posses's only one of the characteristics, thus is a quasi-public good.

Tied in with public goods are free riders. This is the term given to people who directly benefit from the consumption of a public good, yet do no contribute to its provision. So, these are normally holiday-makers from abroad who don't pay taxes in the UK, and thus aren't paying for street lights, beaches etc.

Public goods is a very subjective theory, some people may see a good as both non excludable and non rival whereas another person may see it as only non excludable, so use it cautiously. 

Thanks for reading!

Externalities (Microeconomics)

An externality, in the economic world, occurs when people not directly involved in a decision are affected by it. Some examples of this are fishermen may not be able to fish in a river if someone has contaminated it with rubbish or a new hospital being built will benefit all people in the local area. The term given to those not directly involved in the decision is third party. The third parties in the two examples I've given are the fishermen and the people in the local area.

Linked in with the externalities theory are the costs and benefits that come about from someones decision. The three types are private, external and social. Private costs/benefits are the costs and benefits to the person actually making the decision. Say i decided to pave over my front garden, the private cost would be me losing garden space but the private benefit would be extra parking space. External costs/benefits are the costs and benefits of a decision that someone makes that fall onto the third party. Continuing my example, the external cost of me paving my garden would be the street wouldn't like as nice to the neighbours and passers-by. The external benefits would be a clearer road for the neighbours to drive down because i could then park my car on the new paved area rather than in the street. Finally, the social costs/benefits are the total costs and benefits to society as a whole of the decision. The social cost equals the private costs plus the external costs.

External costs = Social costs - Private costs.
External benefits = Social benefits - Private benefits.

When the social cost is higher than the private cost it means there are external costs in play, these are known as negative externalities. Binge drinking, chewing gum and fly tipping all have negative externalities. The situation of a negative externality can be illustrated on a diagram...

The diagram represents our negative externality. The current equilibrium point is PQ, at this price we are at supply curve 'Supply' but this is only taking into account the private costs of the good. If the external costs are taken into account then the supply curve should shift leftwards to 'Supply 1'. This would raise the price to pay for the extra external costs, as well as lower the supply. The problem with negative externalities is that there is over-production of Q-Q1 and price is lower than it should be. Too many scarce resources are being used, so there is market failure.

Positive externalities work in the same way, this is when the social benefit of a decision is higher than the private benefit.Examples are vaccinations and education. They are the opposite of negative externalities, goods with positive externalities tend to be under-produced. If the external benefits were taken into account then the supply curve would shift to the right, lowering price and increasing production. The under-production here is another form of market failure.

Enjoy. :)

Information Failure (Microeconomics)

Information failure is something that can cause market failure. There isn't really much to information failure, the name says it all really, so this post will remain relatively short. Basically, information failure is when consumers do not receive the correct/enough information before making decisions. I could reel off many examples of this, a few being:

• When consumers aren't aware of the benefits of a good, such as fruit or vegetables, and thus the good is under-consumed.
• When consumers aren't aware of the drawbacks of a good, such as alcohol, and thus the good is over-consumed.

Causes of this lack of awareness stated above is usually things such as persuasive advertising leading to high consumption levels of 'bad' goods or inaccurate product packaging.

One particular type of information failure is asymmetric information. This occurs when information isnt shared equally between two parties. An example of this is visiting the dentist; the dentist has more medical knowledge as you, so you rely on them to pass the information on to you - which they may or may not do.

In brief, information failure is the lack of accurate information given out which leads to mis-allocation of resources, thus market failure! 

Market Failure (Microeconomics)

Market failure is what occurs when the free market economy is left to run itself and resources are allocated inefficiently and not used correctly. For a market to be successful, it must be efficient.A few examples of market failure are the overconsumption of alcohol and tobacco or the underconsumption of health and education. These are examples of market failure because they occur when the economy is left to the free market mechanism and resources aren't being used efficiently or correctly.

Efficiency in an economy can be broken down into two different types: production efficiency and allocative efficiency.

Productive efficiency is achieved when everything that is produced is produced using the least amount of scarce resources. In other words, any point on the PPC curve (Refer to this post on the blog for more about PPC curves). If goods aren't being produced using the least amount of scarce resources then it is said to be productively inefficient and the market's failing.

Allocative efficiency is achieved when customer satisfaction in a market is maximised. So, the quantity supplied must be equal to the quantity demanded - in other words the market must be functioning at the equilibrium position for the market to be allocatively efficient.

There are many causes of this market failure, which will be discussed further in later posts, so stay tuned. Thanks.

Price Elasticity of Supply (Microeconomics)

This will be the last elasticity post for a while, i promise...

Right, so price elasticity of supply is sometimes referred to as PES. It measures the responsiveness of supply to a change in price. Basically, it indicates the amount a supplier is willing to to provide to a market after a change in price. The aim of a supplier is to maximise profits, so therefore the price elasticity of a supply should always be positive (If the price of a good increase so should supply, and vice versa.)

The formula for PES goes like this:

PES = % Change in quantity supplied ÷ % Change in price

As stated previously, the result will almost always be positive as it's highly unlikely that if price falls then suppliers will supply more of a good to the market. The figures gained from the formula are once again important:

• Greater than 1. If the result is over 1 then it tells us that the goods price elasticity of supply is elastic. So a price rise will lead to a more than responsive rise in supply.
• Between 0 and 1. If the result is between 0 and 1 then the goods price elasticity of supply is inelastic. This means a price rise will lead to a less than responsive rise in supply.
• Exactly 1. If the result is 1 then the goods price elasticity of supply is unitary. A change in price leads to an exactly proportional change in supply.

There are three main determinants of the price elasticity of supply of a good. The first is time period. If it takes a lot of time to adjust the supply of a good then it's likely the goods PES will be inelastic. An example of this would be Christmas trees with the long growing period. The next determinant is availability of factors of production. If there is no spare resources or labour to increase production then the PES is likely to be inelastic, and vice versa. Finally, availability of stocks of a product. If a supplier has plenty of goods stored away that can be added to the market should price change then the PES will likely be elastic. If there is no way of storing, or isnt any stored, PES will likely be inelastic. 

An example as usual. The price of shampoo increases by 22% over a period of time, over the same period suppliers supply 15% more shampoo to the market.

PES = 15% ÷ 22% = 0.68

This tells us that the PES of the shampoo is inelastic, suggesting that maybe it takes a long time to produce, there was no extra stored away or there is no spare factors of production. 

That's all for price elasticity of supply.