Government intervention on markets II & Government failure

Government intervention on markets II& Government failure

Maximum and minimum prices • Draw a supply and demand diagram and show an effective maximum price • Draw a supply and demand diagram and show an effective minimum price • How can you remember if the price should be above or below the equilibrium?

Buffer stocks • Some goods increase and decrease in price based on supply • Agricultural products are a good example as supply is affected by the weather • In a buffer stock system, the government can buy surplus or release previously bought surplus to maintain an equilibrium price

Buffer stocks • A good harvest would move S1 to S2 and cause a fall in the price to below P1 • In this case the government would buy the excess supply (Q3 – Q1) to increase the price back to P1 • A decrease in supply to S3 (and price above P1) would lead the government to sell off its buffer stock to decrease the price to P1 S3 S1 S2 Price P1 D Q2 Q1 Q3 Quantity

Buffer stocks What are the advantages and disadvantages of a government using buffer stocks?

Monopolies • Monopolies can be controlled in different ways by the government • Mergers can be blocked to prevent a monopoly • Regulations can be imposed on dominant firms • Artificial barriers can be removed which allow dominance

Mergers • Competition Commission – government body makes sure that no merger is against the public interest (i.e. reduce output/increase prices which monopolies can do) • Utilities have price controls put on them to avoid exploitation • Rail firms can have their franchise taken off them (Connexhttp://news.bbc.co.uk/1/hi/uk/988016.stm )

Natural monopolies e.g. gas pipelines can be put in government control to ensure a fair price • Make market more contestable – removing barriers to entry e.g. legal barriers TV magazines, buses, telecoms – should encourage more entrants and lower prices and increase quality

Redistribution of income • Depends on government priorities • Using tax and spending policies (fiscal policy) • Benefits and provision of public or merit goods are common ways to redistribute income

Government failure • Even with the best intentions, governments can cause failure or make failures worse! • Ineffective intervention – resources are used up and not achieving anything

Political self interest • Decisions may be based on politics rather than need or economic benefit e.g. new schools, hospitals, tax cuts • Lobbying from interest groups can have an effect on decisions

Policy myopia • Looking for quick fixes rather than long term solutions e.g. widening roads rather than solving the causes of congestion • Subsidising loss making industries does nothing in the long term to solve the problems; e.g. car makers, coal – British Leyland (Rover)

Regulatory capture • Where industries under control of a regulator operate in favour of the producer rather than consumer – utilities, telecoms, CAP • Regulators – OFCOM, OFGEM, ORR • Activity P112

Disincentive effects • Some economists argue that attempts to reduce income and wealth inequalities can worsen incentives and productivity • National Minimum Wage – can create real wage unemployment • Raising income tax rates as creates disincentive to work

Consumer preferences • Not everyone votes so basing decisions on elections is not an accurate reflection of consumers’ preferences • The market mechanism is the best way of finding consumer preferences based on people buying and the price at what they buy at

Law of unintended consequences • The law creates unintended or unanticipated consequences • People find ways around laws e.g. shadow markets in tobacco which avoids tax, smuggling

Other issues • Costs of enforcing government intervention can be huge and can outweigh the benefits • Conflicting objectives – e.g. stimulating demand might cause inflation and vice versa • P114 Activity

Government intervention on markets II & Government failure