Economics Assignment: Test Paper on Government Intervention

Economics Assignment: Test Paper on Government Intervention on the Price System Section A: MCQ 1. The following happens when subsidy is introduced by the government, except: a) Equilibrium price of the good decreases b) Supply curve of the good shifts to the right c) No shifts in the demand curve d) Market failure caused by positive externalities overcome 2. The market has failed if: a) Market price of the good decreases b) Many companies are going through a recession c) The opportunity cost of producing the good increases ) Excessive amount of resources is devoted for the production of a good 3. What could be the cause of too little production of a good? a) Increased opportunity cost of producing the good b) Social benefits are not considered c) Presence of negative externalities d) Private benefits are not considered 4. Which of the following is an example of market failure caused by moral hazard? a) A person mistreated with the wrong medicine by a doctor b) High production of cigarettes in a market ) A lighthouse is not available as all fishermen waits for the other to purchase it d) Inaccessibility to education as private sectors monopolize the education sector and sets a very high price Section B: Case Study Indonesia successfully stabilized domestic rice prices for more than a quarter of a century from 1969 to 1996 (see graph below). During that period, domestic prices were roughly equal to world prices on average, but were substantially less volatile. 1. Describe what could cause the peak in the world rice prices in 1974. [2] 2.

State and explain a method of government intervention that could cause the stable domestic rice prices in Indonesia and how it is used to stabilize the price. [5] 3. Draw the graph of the effects of the method you stated in (2) on the demand and supply of rice in Indonesia. [2] 4. State one disadvantage of using the method of government intervention you stated in (2). [1] Section C: Essay 1. Explain the problems caused by externalities and how it can lead to market failure. [8] 2. What are some methods of government intervention and what are the advantages and disadvantages on using these methods? 8] [Virginia – JC1 Cromwell] ANSWER KEY Section A: MCQ 1. C 3. B 2. D 4. A Section B: Case Study 1. Rightward shift of the world demand curve/ leftward shift of the world supply = higher EP 2. Maximum price control & price stabilization policies to lessen the effects of unplanned fluctuations in rice supply which is price volatility. [1 for stating, 1-2 for explanation] -how: -purchase excess stocks during surplus production, release buffer stocks during shortage -result: roughly stable supply = stable price [2-3 for how] [max marks 5] 3. 1 for correct demand and supply curve, 1 for drawing maximum price] 4. Do not promote efficiency/protect farmers from full competition in world markets Section C: Essay 1. definition of externalities [1] private, social and external costs [1] * negative externalities: social cost-private cost (external cost) [3] lead to overproduction (external costs ignored by decision maker, price will be lower) too many resources devoted for production = market failure * positive externalities: social benefits>private benefits 3]lead to underproduction (social benefits ignored, leftward demand curve) too little resources devoted for production = market failure 2. definition of gov. intervention [] methods: regulation, taxes, subsidies, state production * taxes advantages: Reduce/overcome negative externalities Raise gov. ’s revenue. This revenue could be spent on alternatives disadvantages: Difficult to measure the level of negative externality e. g. what is the cost of pollution from a car? Not effective for goods which have inelastic demand subsidies advantages: Reduce/overcome positive externalities, higher demand for merit goods disadvantages: expensive, gov. could impose higher taxes to cover the cost of subsidies may encourage ineffeiciency in firms as they rely on gov. aid * maximum price control advantages: lower price for consumers, price is less volatile or stable disadvantages: lead to lower supply causing shortage, shortage leads to waiting lists and possible emergence of black markets as people try to overcome shortage