2.7 The Role of Government in Microeconomics (DP IB Economics: HL): Flashcards
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Define a mixed economy.
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Define a mixed economy.
A mixed economy is one in which resources are allocated by both market forces and varying degrees of government intervention.
What are the five main reasons governments intervene in markets?
Governments intervene to correct market failure, earn government revenue, promote equity, support firms, and support poorer households.
Define market failure.
Market failure is a less-than-optimal allocation of resources from society's point of view.
True or False?
In maximising their self-interest, firms and consumers will self-correct market failure.
False.
Firms and consumers will not self-correct the misallocation of resources, which is why there is a role for government.
How do governments raise revenue through intervention?
Governments raise revenue through taxation, privatisation, the sale of licenses, and the sale of goods and services.
Define equity.
Equity is a normative concept concerned with reducing the opportunity gap between the rich and the poor.
Governments promote equity partly through minimum laws that protect workers.
Governments promote equity partly through minimum wage laws that protect workers.
Why do governments intervene to support key industries?
Governments support key industries to help them remain competitive in a global economy, using tools such as subsidies, tax breaks, and limiting foreign competition.
Governments support poorer households through redistribution such as tax structures and welfare payments.
Governments support poorer households through redistribution such as progressive tax structures and welfare payments.
Give an example of a government using indirect taxes to correct market failure.
Governments have used indirect taxes on tobacco to reduce its consumption and address market failure.
True or False?
Equity is a positive economic concept.
False.
Equity is a normative concept, as what is considered fair depends on the values of the society and government.
Define an indirect tax.
An indirect tax is a tax paid on the consumption of goods or services, so it is only paid if consumers make a purchase.
Define a specific tax.
A specific tax is a fixed tax of a set amount per unit of output, such as $3.25 per packet of cigarettes.
Define an ad valorem tax.
An ad valorem tax is an indirect tax charged as a percentage of the purchase price, such as VAT.
Why does an indirect tax shift the supply curve to the left?
The supply curve shifts left because the indirect tax is levied on producers, raising their costs of supplying each unit.
True or False?
An ad valorem tax shifts the supply curve parallel to the original.
False.
An ad valorem tax causes the new supply curve to diverge from the original, because a percentage tax means more tax is paid at higher prices.
Define tax incidence.
Tax incidence is the share of an indirect tax borne by producers and by consumers.
When a product is price in demand, producers can pass on a higher proportion of an indirect tax to consumers.
When a product is price inelastic in demand, producers can pass on a higher proportion of an indirect tax to consumers.
For a price-elastic product, does the producer or the consumer bear the greater share of an indirect tax?
The producer bears the greater share of the tax, as only a small proportion can be passed on to consumers.
What determines the effectiveness of an indirect tax in reducing consumption of a demerit good?
Its effectiveness depends on the price elasticity of demand (PED) of the product, as inelastic goods will still be widely purchased.
True or False?
Indirect taxes can create illegal markets.
True.
Higher prices from the tax may lead some consumers to seek illegal markets to avoid paying it.
Define a producer subsidy.
A producer subsidy is a per unit amount of money given to a firm by the government to increase production or the provision of a merit good.
What happens to market price and quantity demanded when a subsidy is introduced?
A subsidy shifts supply to the right, leading to a lower price and a higher quantity demanded.
Give one disadvantage of government subsidies.
Subsidies can distort the allocation of resources, carry an opportunity cost, and disincentivise firms from becoming more efficient.
True or False?
Subsidies can disincentivise firms from becoming more efficient.
True.
The extra funds from a subsidy reduce the pressure on firms to become more competitive or efficient.
Define a price ceiling (maximum price).
A price ceiling is a maximum price set by the government below the free market equilibrium price, above which sellers cannot legally sell.
What market condition does a price ceiling create?
A price ceiling creates excess demand (a shortage), as quantity demanded exceeds quantity supplied at the lower price.
A price ceiling is set the free market equilibrium price.
A price ceiling is set below the free market equilibrium price.
True or False?
A price ceiling always increases the total consumer surplus in the market.
False.
In the longer term suppliers supply less, so overall consumer surplus decreases, even though some consumers who still buy at the lower price gain.
Why do price ceilings often encourage illegal markets?
The unmet demand from the shortage leads desperate buyers to turn to illegal (black or grey) markets.
Give one disadvantage of a price ceiling for producers.
Producers' producer surplus falls, because they must sell at a price below what they would usually receive.
Define a price floor (minimum price).
A price floor is a minimum price set by the government above the free market equilibrium price, below which sellers cannot legally sell.
What market condition does a price floor create?
A price floor creates excess supply (a surplus), as quantity supplied exceeds quantity demanded at the higher price.
Governments often use a price floor to help or to decrease consumption of a demerit good.
Governments often use a price floor to help producers or to decrease consumption of a demerit good.
True or False?
Governments purchase the excess supply of a demerit good caused by a price floor.
False.
Governments will not purchase the excess supply of a demerit good; the aim is instead for output to fall.
Give one disadvantage of a price floor in an agricultural market.
It costs the government to purchase and store the excess supply, and farmers may become over-dependent on this help.
Define a national minimum wage (NMW).
A national minimum wage is a legally imposed wage level, set above the market rate, that employers must pay their workers.
What is the effect of a minimum wage set above the equilibrium wage on the labour market?
It creates an excess supply of labour, as the supply of labour rises and firms' demand for labour falls, causing potential unemployment.
Give one advantage of a national minimum wage.
It guarantees a minimum income for the lowest paid workers, which can also increase consumption in the economy.
True or False?
A minimum wage may force firms to lay off some workers.
True.
A minimum wage raises firms' production costs, and if they cannot raise prices they may lay off workers, increasing unemployment.
Why does the government directly provide public goods?
Public goods are not provided by private firms due to the free rider problem, yet they are beneficial for society.
Directly provided public goods are usually free at the point of and accessible to everyone regardless of income.
Directly provided public goods are usually free at the point of consumption and accessible to everyone regardless of income.
Give one disadvantage of the direct provision of public services.
It is paid for through general taxation and carries an opportunity cost, and free products may create excess demand and long waiting times.
Define legislation.
Legislation is the process of creating laws.
Define regulation.
Regulation is the process of monitoring and enforcing laws.
Define command and control.
Command and control is the use of legislation and regulation, involving ongoing government intervention.
True or False?
Regulation can create underground (illegal) markets.
True.
Regulation may push activity into underground markets, which could generate even higher external costs on society.
Define a consumer nudge.
A consumer nudge guides people towards certain decisions or actions while still allowing them to retain their freedom of choice.
On which branch of economics are consumer nudges based?
Consumer nudges are based on the principles of behavioural economics.
What is a 'default option' as a nudge?
A default option is a pre-selected choice that people tend to stick with unless they actively opt out, such as organ donation.
Nudges should be designed with , respect for individual autonomy, and clear societal benefits in mind.
Nudges should be designed with transparency, respect for individual autonomy, and clear societal benefits in mind.
True or False?
Nudges remove an individual's freedom of choice.
False.
Nudges preserve freedom of choice, steering individuals towards certain decisions while still allowing them to choose otherwise.
Give one disadvantage of using nudges to influence behaviour.
Nudges can be seen as manipulative, raising ethical concerns about autonomy, and they may have unintended consequences or variable success.
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