Financial Market Failure: Evaluate microeconomic and macroeconomic policies that might be used to correct
financial market failures in the UK economy
• Financial market failure occurs when money, equity + bond markets fail achieve efficient and/or equitable outcome; can lead to
economic + social costs including macro instability + loss of trust + confidence in financial institutions
• Financial market failures include market rigging, speculative bubbles, information failures + low levels of market cooperation
between suppliers
Micro point 1
• Address financial market failure would be to provide more licences to encourage smaller challenger banks to enter the industry
• This policy would increase the contestability of retail banking + therefore reduce the monopoly power of established banks such
as HSBC + Barclays
• More competition can lead to better outcomes including lower charges on overdrafts + improved interest rates for savers
• However, behavioural economics argues consumers have a strong default choice when deciding what bank to use; the
inconvenience involved in switching means that challenger banks often find it hard to achieve the economies of scale needed to
compete effectively
Micro point 2
• 2nd micro policy would be to introduce price capping on interest rates charged by household loans companies
• Payday loans companies often charge very high interest rates to families which can lead to mounting debt problems + financial
distress; a cap on interest charges reduces the burden of servicing debt for some of the poorest households + potentially reduce
income inequality
• A possible consequence with this policy is that lenders will all charge the maximum capped rate rather than compete at lower
interest rates; they could also impose extra charges as a way of avoiding the price ceiling
Macro point 1
• Bank of England should impose a higher liquidity ratio (the ration of liquid assets held by a bank to their total assets)
• If banks required hold more liquid reserves, they will have a stronger capital base to help them withstand a future downturn in
the economy which could lead to a rise in loan defaults + sub-prime debts
• This will promote financial + macroeconomic stability for the UK in the long term
• However, risk that stricter controls on bank lending using capital ratios may limit the amount of money that banks are able to
lend business for debt finance; could reduce business investment, impacting both aggregate supply + aggregate demand
Macro point 2
• Central banks to return gradually towards normal level of interest rates
• The base rate set by B of E if too low can lead to speculative activity in property + equity markets + lead to unsustainable bubble
+ asset prices above fair value
• A downside of the interest rate as of May 2023 at 4.5% results in households obtaining increased interest rate payments on
debt + creates a vulnerability/decline in confidence amongst consumers (with consumers circa 63% AD equation likely could
push the UK into recession…forecast growth end 2023 -0.2%)
Farm subsidies: Evaluate the microeconomic and macroeconomic effects of the UK government ending
subsidises to farmers
Micro point 1
• Ending subsidies may lead to a fall in revenues + profits + cause some farmers to leave the industry
➢ A subsidy is a financial payment to farmers either as a direct payment or a subsidy
per unit of production
➢ If the subsidy ended, then producer prices would revert back to a lower equilibrium
level
➢ Lower prices + a fall in output would cause a fall in total revenue; assuming costs
remain unchanged + reduce industry profits
➢ If farmers are making subnormal profits (economic losses) then they may opt to
leave the industry which will cause a fall in supply
➢ Therefore, eliminating subsidies could cause a recession in the UK farming sector
which may lead to an increase in unemployment + fall in median incomes
, Evaluation of point 1
• Farmers might respond to the ending of subsidies by attempting to increase productivity which will cause a fall in unit costs
• Invest new, more efficient capital machinery which automates the growing process and allows farmers to grow more
throughout the year
• Larger scale farmers are most likely to be able to afford this whereas smaller farmers might have to respond my improving the
quality of their output + branding their own produce to enable them to get a better market price + remain commercially viable
• Farm subsidies in New Zealand were removed around 30 years ago + whilst this caused unemployment + falling land values in
the short term, the free-market approach led to the industry becoming more efficient + diversified, cheaper land brought new
farmers into the industry + New Zealand has become a major global food exporter
Micro point 2
• Higher food prices for consumers + subsequent fall in economic welfare; inward shift of market supply making food more
expensive at retail level
• Food bills on average largest category of spending + if food prices rise, this reduces their real disposable incomes + loss of
consumer surplus (left shift supply diagram highlighting fall consumer surplus)
• The welfare losses from subsidy-free farming might be felt most by low-income families so this may have a regressive effect
• Risk that higher food prices may lead to rise in food poverty + perhaps + increase in under-nourishment
Evaluation of point 2
• In theory ending subsidies may lead to increased prices for consumers, in practice the impact in the medium term may be less
significant
• Firstly, outside the EU, the UK may be able to negotiate free trade deals with countries who have a comparative advantage in
food production (e.g., UK Free Trade agreement with New Zealand 28th Feb 2022) (diagram highlighting domestic economy
opening up to foreign imports + showing lower price with perfectly elastic world supply)
• UK will be able to import food at lower prices than when inside an EU customs union
• Trade liberalisation can have a direct beneficial impact on the prices that consumers pay for food in the supermarkets
• Secondly, higher prices (along with behavioural nudges such as ending ‘best before dates’ for foods) might act as an incentive
for consumers to make greater effort to cut food waste; in the longer term will help to keep weekly food bills under control
Macro point 1
• UK government would save >$3bn pa in spending leading to a lower fiscal deficit (opportunity cost theory in gov spending)
• A lower fiscal deficit will help the government size of the national debt + perhaps release funds for other projects
• Money previously used for subsidies might help to fund improvements in transport or telecommunications in rural areas
• If UK farming becomes more efficient + profitable in the long run, the government will generate fresh tax revenues in the year
ahead
• Free-market economists argue that subsidies distort markets + make a country less competitive in the long run (left shift LRAS)
due a façade of increased price competitiveness under subsidies
Evaluation Macro point 1
• Argument seems plausible but must be placed into context; UK farm subsidies 2017 £2.3bn but contrasts with an annual fiscal
deficit of £43bn + accumulated national debt £1.8bn
• Ending farm subsidies on their own will make little difference to the state of government finances; indeed, the probable
contraction in output, profits and jobs in farming subsidies ended abruptly may see the fiscal deficit increase
• A fall in revenues from corporation tax, national insurance + stamp duty; especially if farm land prices fall + fewer farms bought
+ sold
• A contraction in farm output + incomes may trigger negative multiplier effects + risk causing a recession in areas where farming
remains a major part of the local + regional economy
Conclusion
• Farming in UK contributes <1% of GDP (by value added); a major reform of ending subsidies would have potentially large
macroeconomic effects.
• In 2016 the UK supplied 49% of the food consumed in the UK + the ending of subsidies would – in the short term at least – likely
lead to an increase in food imports which will worsen the UK’s current account deficit.
• Farming would also be under pressure to increase efficiency and this may increase unemployment + risk rise in structural
unemployment.
• Necessity is often the mother of invention; so perhaps without a subsidy, UK farmers would be more successful in diversifying
production in a sustainable way to increase output and quality for consumers. That would certainly be one of the aims of ending
production subsidies
financial market failures in the UK economy
• Financial market failure occurs when money, equity + bond markets fail achieve efficient and/or equitable outcome; can lead to
economic + social costs including macro instability + loss of trust + confidence in financial institutions
• Financial market failures include market rigging, speculative bubbles, information failures + low levels of market cooperation
between suppliers
Micro point 1
• Address financial market failure would be to provide more licences to encourage smaller challenger banks to enter the industry
• This policy would increase the contestability of retail banking + therefore reduce the monopoly power of established banks such
as HSBC + Barclays
• More competition can lead to better outcomes including lower charges on overdrafts + improved interest rates for savers
• However, behavioural economics argues consumers have a strong default choice when deciding what bank to use; the
inconvenience involved in switching means that challenger banks often find it hard to achieve the economies of scale needed to
compete effectively
Micro point 2
• 2nd micro policy would be to introduce price capping on interest rates charged by household loans companies
• Payday loans companies often charge very high interest rates to families which can lead to mounting debt problems + financial
distress; a cap on interest charges reduces the burden of servicing debt for some of the poorest households + potentially reduce
income inequality
• A possible consequence with this policy is that lenders will all charge the maximum capped rate rather than compete at lower
interest rates; they could also impose extra charges as a way of avoiding the price ceiling
Macro point 1
• Bank of England should impose a higher liquidity ratio (the ration of liquid assets held by a bank to their total assets)
• If banks required hold more liquid reserves, they will have a stronger capital base to help them withstand a future downturn in
the economy which could lead to a rise in loan defaults + sub-prime debts
• This will promote financial + macroeconomic stability for the UK in the long term
• However, risk that stricter controls on bank lending using capital ratios may limit the amount of money that banks are able to
lend business for debt finance; could reduce business investment, impacting both aggregate supply + aggregate demand
Macro point 2
• Central banks to return gradually towards normal level of interest rates
• The base rate set by B of E if too low can lead to speculative activity in property + equity markets + lead to unsustainable bubble
+ asset prices above fair value
• A downside of the interest rate as of May 2023 at 4.5% results in households obtaining increased interest rate payments on
debt + creates a vulnerability/decline in confidence amongst consumers (with consumers circa 63% AD equation likely could
push the UK into recession…forecast growth end 2023 -0.2%)
Farm subsidies: Evaluate the microeconomic and macroeconomic effects of the UK government ending
subsidises to farmers
Micro point 1
• Ending subsidies may lead to a fall in revenues + profits + cause some farmers to leave the industry
➢ A subsidy is a financial payment to farmers either as a direct payment or a subsidy
per unit of production
➢ If the subsidy ended, then producer prices would revert back to a lower equilibrium
level
➢ Lower prices + a fall in output would cause a fall in total revenue; assuming costs
remain unchanged + reduce industry profits
➢ If farmers are making subnormal profits (economic losses) then they may opt to
leave the industry which will cause a fall in supply
➢ Therefore, eliminating subsidies could cause a recession in the UK farming sector
which may lead to an increase in unemployment + fall in median incomes
, Evaluation of point 1
• Farmers might respond to the ending of subsidies by attempting to increase productivity which will cause a fall in unit costs
• Invest new, more efficient capital machinery which automates the growing process and allows farmers to grow more
throughout the year
• Larger scale farmers are most likely to be able to afford this whereas smaller farmers might have to respond my improving the
quality of their output + branding their own produce to enable them to get a better market price + remain commercially viable
• Farm subsidies in New Zealand were removed around 30 years ago + whilst this caused unemployment + falling land values in
the short term, the free-market approach led to the industry becoming more efficient + diversified, cheaper land brought new
farmers into the industry + New Zealand has become a major global food exporter
Micro point 2
• Higher food prices for consumers + subsequent fall in economic welfare; inward shift of market supply making food more
expensive at retail level
• Food bills on average largest category of spending + if food prices rise, this reduces their real disposable incomes + loss of
consumer surplus (left shift supply diagram highlighting fall consumer surplus)
• The welfare losses from subsidy-free farming might be felt most by low-income families so this may have a regressive effect
• Risk that higher food prices may lead to rise in food poverty + perhaps + increase in under-nourishment
Evaluation of point 2
• In theory ending subsidies may lead to increased prices for consumers, in practice the impact in the medium term may be less
significant
• Firstly, outside the EU, the UK may be able to negotiate free trade deals with countries who have a comparative advantage in
food production (e.g., UK Free Trade agreement with New Zealand 28th Feb 2022) (diagram highlighting domestic economy
opening up to foreign imports + showing lower price with perfectly elastic world supply)
• UK will be able to import food at lower prices than when inside an EU customs union
• Trade liberalisation can have a direct beneficial impact on the prices that consumers pay for food in the supermarkets
• Secondly, higher prices (along with behavioural nudges such as ending ‘best before dates’ for foods) might act as an incentive
for consumers to make greater effort to cut food waste; in the longer term will help to keep weekly food bills under control
Macro point 1
• UK government would save >$3bn pa in spending leading to a lower fiscal deficit (opportunity cost theory in gov spending)
• A lower fiscal deficit will help the government size of the national debt + perhaps release funds for other projects
• Money previously used for subsidies might help to fund improvements in transport or telecommunications in rural areas
• If UK farming becomes more efficient + profitable in the long run, the government will generate fresh tax revenues in the year
ahead
• Free-market economists argue that subsidies distort markets + make a country less competitive in the long run (left shift LRAS)
due a façade of increased price competitiveness under subsidies
Evaluation Macro point 1
• Argument seems plausible but must be placed into context; UK farm subsidies 2017 £2.3bn but contrasts with an annual fiscal
deficit of £43bn + accumulated national debt £1.8bn
• Ending farm subsidies on their own will make little difference to the state of government finances; indeed, the probable
contraction in output, profits and jobs in farming subsidies ended abruptly may see the fiscal deficit increase
• A fall in revenues from corporation tax, national insurance + stamp duty; especially if farm land prices fall + fewer farms bought
+ sold
• A contraction in farm output + incomes may trigger negative multiplier effects + risk causing a recession in areas where farming
remains a major part of the local + regional economy
Conclusion
• Farming in UK contributes <1% of GDP (by value added); a major reform of ending subsidies would have potentially large
macroeconomic effects.
• In 2016 the UK supplied 49% of the food consumed in the UK + the ending of subsidies would – in the short term at least – likely
lead to an increase in food imports which will worsen the UK’s current account deficit.
• Farming would also be under pressure to increase efficiency and this may increase unemployment + risk rise in structural
unemployment.
• Necessity is often the mother of invention; so perhaps without a subsidy, UK farmers would be more successful in diversifying
production in a sustainable way to increase output and quality for consumers. That would certainly be one of the aims of ending
production subsidies
