Deck 3: Government in the Economy: The Limits of Intervention

Question 1

What is the rationale that is used to justify government intervention in markets? List some examples of ways in which government actions have specific effects on market outcomes.

Answer 1

The rationale for government intervention in markets is to correct market failures and ensure that the economy operates efficiently and fairly. Market failures can occur due to externalities, public goods, natural monopolies, and asymmetric information. In these cases, the free market may not allocate resources efficiently, leading to suboptimal outcomes.

Examples of government intervention in markets include:

1. Regulation: Governments may impose regulations on industries to protect consumers, workers, and the environment. For example, the Environmental Protection Agency (EPA) sets emission standards for vehicles and regulates the disposal of hazardous waste.

2. Taxation: Governments use taxes to influence market outcomes. For example, taxes on cigarettes and alcohol are used to discourage consumption and reduce negative externalities.

3. Subsidies: Governments may provide subsidies to certain industries to encourage production or consumption. For example, subsidies for renewable energy sources aim to promote their use and reduce reliance on fossil fuels.

4. Antitrust laws: Governments use antitrust laws to prevent monopolies and promote competition. For example, the breakup of AT&T in the 1980s aimed to increase competition in the telecommunications industry.

5. Public goods provision: Governments provide public goods such as national defense, infrastructure, and education, which may not be efficiently provided by the private sector.

6. Price controls: Governments may impose price controls to prevent price gouging or ensure affordability of essential goods and services.

Overall, government intervention in markets can have specific effects on market outcomes by influencing prices, quantities, competition, and resource allocation. These interventions are aimed at addressing market failures and promoting the overall welfare of society.

Question 2

Summarize the "ideal model" of government intervention. In what ways does actual government intervention differ from the assumptions of the ideal model?

Answer 2

The "ideal model" of government intervention suggests that government intervention should aim to correct market failures, promote economic stability, and ensure social welfare. In this model, government intervention is seen as necessary to address issues such as externalities, public goods, and monopolies, and to provide a safety net for vulnerable populations.

However, in reality, government intervention often differs from the assumptions of the ideal model in several ways. First, government intervention can be influenced by political considerations, leading to policies that may not always align with economic efficiency or social welfare. Additionally, government intervention can be subject to bureaucratic inefficiencies and regulatory capture, where special interests influence policy decisions to benefit themselves at the expense of the broader public.

Furthermore, the effectiveness of government intervention can be limited by imperfect information and unintended consequences. For example, government policies intended to address market failures may not always achieve their desired outcomes, and can sometimes create new distortions in the economy. Moreover, government intervention can also be constrained by budgetary limitations and the potential for unintended consequences, such as moral hazard and rent-seeking behavior.

Overall, while the ideal model of government intervention emphasizes the role of government in promoting economic efficiency and social welfare, the actual practice of government intervention often falls short of these ideals due to political, bureaucratic, and economic constraints.

Question 3

Assume that a municipal government is considering a proposal for acquiring land to build and develop a major airport. How might that government employ the use of cost-benefit analysis in its efforts to reach a decision on this proposal?

Answer 3

Cost-benefit analysis can be a valuable tool for the municipal government to use in evaluating the proposal for acquiring land to build and develop a major airport. The government can use this analysis to weigh the potential costs and benefits associated with the project in order to make an informed decision.

First, the government can identify and quantify the costs associated with acquiring the land, building the airport infrastructure, and ongoing operational expenses. This can include expenses such as land acquisition costs, construction costs, maintenance costs, and potential environmental impact costs.

Next, the government can also identify and quantify the potential benefits of the airport project. This can include economic benefits such as job creation, increased tourism, and improved transportation infrastructure. It can also include social benefits such as improved connectivity and convenience for residents and businesses.

Once the costs and benefits are identified and quantified, the government can then compare them to determine if the benefits outweigh the costs. This can help the government make an informed decision on whether the project is financially viable and if the potential benefits justify the investment.

Additionally, the government can also consider the potential risks and uncertainties associated with the project and incorporate them into the cost-benefit analysis. This can help the government make a more comprehensive assessment of the project's potential impact.

Overall, by employing cost-benefit analysis, the municipal government can make a more informed decision on the proposal for acquiring land to build and develop a major airport, taking into account the potential costs, benefits, and risks associated with the project.

Question 4

Define each of the following terms. What is the relevance of each to economic policymaking?
a. Market imperfection
b. Market failure
c. Economic instability

Question 5

Critics of the degree of intervention by government in the American economy cite a number or real economic problems that might emerge from overly zealous efforts at government intervention. List five undesirable economic outcomes that might be the by-product of excessive government, giving a specific example of each.

Question 6

Summarize the "American Farm Problem." What public policies have been tried in the past to alleviate this problem, and to what effect?

Question 7

When an effective support price (price floor) is imposed, what are the economic effects?

Question 8

What are the economic effects of imposing an effective price ceiling?

Question 9

Summarize the argument for and against a legal minimum wage. Which argument do you agree with? Why?

Question 10

How can it be argued that rent controls in New York City, which were originally introduced to aid and protect low income renters, have had over the long term precisely the opposite effects?

Question 11

"Placing price controls on oil and gas has in the long term the effect of creating scarcity and forcing prices of these goods upward." Comment on this statement.

Question 12

Our energy policies since 1973 have substantially reduced U.S. dependence on the world for energy supply.

Question 13

The decade of the 1930s saw a vast enlargement of the extent and degree of government intervention in the American economy.

Question 14

Markets' efficiency conditions are frequently used as an argument against government intervention in markets.

Question 15

The marginal cost curve and the marginal benefit curve faced by a competitive industry are respectively the supply and demand curves for that industry.

Question 16

The marginal social benefit curve (MSB) is downward sloping to the right because early units obtained of a particular government activity (environmental controls to protect air quality, for instance) provide much greater benefits per unit than the benefits provided by later units.

Question 17

Although a number of difficulties are associated with government when it intervenes in markets, inadequate use of knowledge and expertise is not one of them.

Question 18

An advantage government possesses over private markets is that the market always has a short-run focus on its activities while government is always able to exercise a long-run view.

Question 19

The "farm problem" has many roots, but one of its most important is the fact that in the 20th century American agricultural production and efficiency gains have shifted our agricultural supply curve to the right by a much greater extent than the demand curve for agricultural products has shifted to the right.

Question 20

As a rule, demand for agricultural products tends to be highly elastic while long-
term supply is inelastic.

Question 21

An effective minimum wage law will lower the demand for labor.

Question 22

An effective minimum wage law will probably have an unemployment effect on
the lowest skilled and lowest paid workers.

Question 23

Rent controls were used briefly in New York City during World War II due to a sudden increase in war-generated housing demand but were later withdrawn so as
to stimulate new housing construction.

Question 24

As long as rent control exists, we can expect the housing market affected by these controls to suffer from housing shortages.

Question 25

A price floor is usually introduced when the equilibrium price is perceived to be
"too high."

Question 26

The reason that government introduced price controls during World War II was that war production reduced civilian goods production, therefore triggering a great inflation in prices of scarce consumer goods.

Question 27

The public policy device most likely to be directed at the problem of monopolistic power as it might develop in most product markets is:

A) the independent regulatory commission
B) fiscal policy
C) monetary policy
D) government ownership
E) antitrust policy

Question 28

A well-functioning, efficient market assumes:

A) all markets are subject to failures that require government correction
B) that left to itself the market will create production and distribution
Equilibrium in which no further gains are obtainable without someone suffering losses
C) that the "ideal government model" should focus on redistribution efforts
D) the existence of a downward sloping supply curve
E) none of the above

Question 29

If we were producing commodity Q at a level of output where MC > MB, we would be better served:

A) to increase output until MC = MB
B) to decrease output because we are currently overproducing Q
C) by having government lower the price of Q
D) by having government raise the price of Q
E) none of the above

Question 30

All but which of the following are frequently alleged to be shortcomings of market interventions by government:

A) excessive bureaucracy
B) timing problems and delays
C) high external cost
D) very low wages
E) excessive influence by political interest groups

Question 31

The setting of a legal price floor, such as is common practice in American
Agricultural policy, has the economic effect of:

A) setting legal prices below equilibrium market price
B) forcing resources out of agriculture
C) causing surpluses in certain agricultural markets
D) taxing agricultural producers

Question 32

Which of the following is not the likely outcome of establishing a legal price floor?

A) surplus goods are produced
B) sellers receive artificially high incomes
C) buyers pay higher prices
D) the market is not in equilibrium
E) resources are discouraged from entering the affected industry

Question 33

In a free market, a general economic downturn in the economy (such as a
Recession) will cause:

A) a shortage of labor supply
B) a fall in wage rates and in the number of workers employed
C) a fall in wage rates and an increase in the number of workers employed
D) a decrease in the supply of labor
E) a decline in unemployment rates

Question 34

Which of the following is not likely to be the result of an effective rent control?

A) a decrease in demand for housing
B) in the long run, a reduction in new housing construction
C) high and rising housing costs in non-controlled segments of the housing market
D) underallocation of resources to housing

Question 35

Which of the following has been true of New York City housing markets since
World War II?

A) all war time rent controls have been removed
B) New York City has generally suffered from a shortage of higher-priced housing
C) with rent controls, there has been a tendency to overbuild low cost housing
D) all of the above
E) none of the above

Question 36

One of the effects of our efforts in the 1970s to set ceiling prices on American-
Produced petroleum was

A) to bring stability to all energy markets
B) to reduce American consumption of petroleum products
C) to produce a domestic surplus in oil production
D) to shift consumption to other energy fuels
E) to increase our importation of foreign oil

Question 37

Answer the next two questions on the basis of the following diagram:


-The diagram is used to show:

A) the proper distribution of income
B) the economy's best tax handles
C) the opportunity cost of public versus private goods
D) the optimal level of government intervention
E) new theories of international trade

Question 38

Answer the next two questions on the basis of the following diagram:


-If MSC is marginal social cost and MSB is marginal social benefit, then:

A) the optimal level of government intervention is Q₀
B) no conclusion can be reached
C) society should choose Q₁ level of government intervention
D) at Q₂ marginal social cost is less than marginal social benefit

Question 39

Which of the following are possible shortcomings of both the market economy and government intervention?

A) overresponsiveness to political pressure groups
B) the creation of externalities
C) taxes and subsidies
D) response to supply and demand

Question 40

The economic approach to determining the proper level of government
Intervention is to:

A) hold a telephone referendum on every issue
B) privatize all government functions
C) establish a very large planning agency in government to control the economy
D) rely upon a benefit-cost analysis of intervention

Question 41

Net benefits are maximized:

A) when marginal benefits equal marginal costs
B) when marginal benefits reach zero
C) when marginal benefits exceed marginal costs
D) only when marginal costs are constant