9708 · 8.1
Government policies to achieve efficient resource allocation and correct market failure flashcards
Revision flashcards for Cambridge 9708 Government policies to achieve efficient resource allocation and correct market failure (syllabus 8.1). Flip, recall, then mark a real past-paper question.
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What is a Pigouvian tax?
A tax set equal to the marginal external cost so that MPC shifts up to MSC - internalising the negative externality.
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How does a subsidy correct a positive externality?
It shifts MPB up toward MSB (e.g. for education, vaccinations) or MPC down, raising output from the market level toward the socially optimal level.
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What are tradable pollution permits?
A 'cap and trade' system. The government sets a total cap on emissions and issues permits. Firms can trade these, ensuring the pollution target is met at the lowest overall cost.
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What is the difference between command-and-control and market-based policies?
Command-and-control (e.g., regulation) sets direct limits. Market-based policies (e.g., taxes, permits) use price signals to create incentives, which is often more cost-effective.
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What is government failure?
When government intervention fails to improve resource allocation or leads to a net welfare loss. Causes include imperfect information, bureaucracy, lobbying, and unintended consequences.
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When is a tax preferred to regulation?
When the marginal external cost is measurable and firms have different abatement costs. A tax provides flexibility and a continuous incentive to reduce pollution, whereas regulation can be rigid and inefficient.
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What is a Pigouvian tax?
A tax levied on any market activity that generates negative externalities. The tax is intended to correct an inefficient market outcome by being set equal to the marginal external cost of the externality at the socially optimal output.
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How does a subsidy correct the market failure of a positive externality?
It lowers the private cost of production or increases the private benefit of consumption. This shifts the MPC curve down (or the MPB curve up), encouraging an increase in output from the inefficient market equilibrium (Qe) to the socially optimal equilibrium (Qso), eliminating the deadweight welfare loss.
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What is the primary advantage of tradable permits over direct regulation?
Tradable permits provide a financial incentive for firms to find the cheapest way to reduce pollution, leading to the same overall pollution reduction at a lower total cost to the economy compared to a 'one-size-fits-all' regulation which may be inefficient.
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Define 'deadweight welfare loss' in the context of an externality.
The loss of economic efficiency that occurs when the free market equilibrium is not at the socially optimal level. It represents the total loss of consumer and producer surplus due to the over-production (negative externality) or under-production (positive externality) of a good.
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What is 'government failure'?
A situation where government intervention to correct a market failure creates inefficiency and leads to a net welfare loss. Causes include imperfect information, high administrative costs, unintended consequences, and political self-interest.