Economics A Level Year 2 – Chapter 3
CONTENT
Government microeconomic intervention
Policies to achieve efficient resource
allocation and correct market failure
Equity and policies towards income and
wealth redistribution
Labour market forces and government
intervention:
- (i) demand for and supply of labour
- (ii) wage determination in perfect markets
- (iii) wage determination in imperfect
markets
Government failure in microeconomic
intervention
, Policies to achieve efficient resource
allocation and correct market failure
Nationalisation or
Subsidies Privatisation
Indirect
taxes Deregulation
or Regulation
POLICIES TO CORRECT
MARKET FAILURE
Provision of Pollution
information permits
State provision Behavioural insights
of public goods and ‘nudge’ theory
TAXES
The government uses taxes to correct market failure with demerit goods,
which tend to be habit-forming and hence have inelastic demand.
Indirect taxes: Imposed by government and they increase production costs for
producers. Shifts supply curve left, decreasing supply and increases market
price.
There can be specific taxes – a set tax per unit – and ‘Ad Valorem’ taxes – these
are taxes as a percentage, such as VAT which adds 20% of unit price. VAT on
tobacco, a demerit good, will raise a lot of government revenue as demand is
inelastic (so demand only falls slightly with tax) and the burden falls mostly on
consumers.
INTERNALISING AN EXTERNALITY: An attempt to deal with an externality by
bringing an external cost or benefit into the price system. Taxes are sometimes
implemented with the aim of internalising an externality: so, the firm causing
negative externalities, for eg. Pollution, pays in taxes for the damage.
,Taxes with different elasticities:
S+tax
P2
PERFECTLY ELASTIC SUPPLY TAX PAID BY TAX
CONSUMER
(Tax wholly falls on consumer) P1 S
D
Q2 Q1 Quantity
S+tax
PERFECTLY INELASTIC SUPPLY S
P2
(Tax wholly falls on consumer)
TAX PAID BY
CONSUMER
P1
D
Quantity
ADVANTAGES DISADVANTAGES
Overcome market failure and negative Expensive for government to collect
externalities
Easier for firms to pay taxes than If taxes are regressive, they impact the poor
consumers most
Increases tax revenue for government to Encourages tax evasion
, spend on public goods
Internalises harmful effects Possibly inflationary
Achieves allocative efficiency if they put
P=MC
Achieves social efficiency MSC=MSB
Tax burden with different PEDs
S+tax
ELASTIC DEMAND
PED>1 S
P2
Tax burden falls mostly
P1
on PRODUCER*
PRODUCER*
P3
Quantity
Q2 Q1
S+tax
INELASTIC DEMAND S
P2
PED<1
CONSUMER*
Tax burden falls mostly P1
on CONSUMER* P3
CONTENT
Government microeconomic intervention
Policies to achieve efficient resource
allocation and correct market failure
Equity and policies towards income and
wealth redistribution
Labour market forces and government
intervention:
- (i) demand for and supply of labour
- (ii) wage determination in perfect markets
- (iii) wage determination in imperfect
markets
Government failure in microeconomic
intervention
, Policies to achieve efficient resource
allocation and correct market failure
Nationalisation or
Subsidies Privatisation
Indirect
taxes Deregulation
or Regulation
POLICIES TO CORRECT
MARKET FAILURE
Provision of Pollution
information permits
State provision Behavioural insights
of public goods and ‘nudge’ theory
TAXES
The government uses taxes to correct market failure with demerit goods,
which tend to be habit-forming and hence have inelastic demand.
Indirect taxes: Imposed by government and they increase production costs for
producers. Shifts supply curve left, decreasing supply and increases market
price.
There can be specific taxes – a set tax per unit – and ‘Ad Valorem’ taxes – these
are taxes as a percentage, such as VAT which adds 20% of unit price. VAT on
tobacco, a demerit good, will raise a lot of government revenue as demand is
inelastic (so demand only falls slightly with tax) and the burden falls mostly on
consumers.
INTERNALISING AN EXTERNALITY: An attempt to deal with an externality by
bringing an external cost or benefit into the price system. Taxes are sometimes
implemented with the aim of internalising an externality: so, the firm causing
negative externalities, for eg. Pollution, pays in taxes for the damage.
,Taxes with different elasticities:
S+tax
P2
PERFECTLY ELASTIC SUPPLY TAX PAID BY TAX
CONSUMER
(Tax wholly falls on consumer) P1 S
D
Q2 Q1 Quantity
S+tax
PERFECTLY INELASTIC SUPPLY S
P2
(Tax wholly falls on consumer)
TAX PAID BY
CONSUMER
P1
D
Quantity
ADVANTAGES DISADVANTAGES
Overcome market failure and negative Expensive for government to collect
externalities
Easier for firms to pay taxes than If taxes are regressive, they impact the poor
consumers most
Increases tax revenue for government to Encourages tax evasion
, spend on public goods
Internalises harmful effects Possibly inflationary
Achieves allocative efficiency if they put
P=MC
Achieves social efficiency MSC=MSB
Tax burden with different PEDs
S+tax
ELASTIC DEMAND
PED>1 S
P2
Tax burden falls mostly
P1
on PRODUCER*
PRODUCER*
P3
Quantity
Q2 Q1
S+tax
INELASTIC DEMAND S
P2
PED<1
CONSUMER*
Tax burden falls mostly P1
on CONSUMER* P3
