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Using the data and your economic knowledge, evaluate the economic case for and against government intervention in car markets.

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Introduction

´╗┐Christos Singh Using the data and your economic knowledge, evaluate the economic case for and against government intervention in car markets. Markets are generally thought to work well. Changes in the relative prices of goods serve to create signals and incentives to which firms and consumers respond, allocating resources to where they produce the most utility. I These principles can easily be applied to car markets. At the time of the extracts, for example, there was a large drop in the market for new cars, especially luxury ones, due to the global economic downturn. New cars are a normal good, such as a decline in income sees a fall in demand for them. More than that, they are likely to be income elastic, with demand falling more than proportionately in response to any fall in income. This is because consumers can keep their existing cars for longer, or turn to public transport, in order to spend more of their limited income on necessities during difficult periods. This effect was reinforced during the economic downturn by a lack of availability of credit with which to finance car purchases. ...read more.

Middle

These regional economies may suffer downwards multiplier effects and serious economic problems. A second likely failure involving car markets relates to the negative externalities that are generated by private cars, especially fossil fuelled ones. The burning of fossil fuels by cars generates costs to third parties through carbon dioxide emissions and a contribution to global warming, as well as by generating air pollution. Those who suffer the effects have no way of using the market to charge those who have caused their suffering, and therefore are not compensated. The result is a misallocation of resources through an over-production of fossil-fuelled cars, and a deadweight welfare loss. This is illustrated in the diagram below. The market may lead to an over-production of fossil-fuelled cars There is enough evidence of market failure to support some sort of government intervention in car markets. Negative externalities are notoriously difficult to measure, because they are not priced in markets, but those associated with global warming appear likely to be large. On this basis, there should be some government support for substitutes to conventional engines, such as electric cars. ...read more.

Conclusion

It would be possible to spend considerable amounts on subsidy without succeeding in enlarging the market to the sort of size where economies of scale would enable it to thrive. The case for intervention in car markets for failures relating to a lack of equity is not as clear cut as the case for supporting environmentally friendly cars. It might be justified to support the car industry through short term difficulties as long as the market is commercially viable in the long term, which may well be the case given the UK?s relatively flexible labour market and pool of skilled workers, which has attracted significant foreign direct investment into the UK car industry in recent years. For any parts of the industry which cannot compete effectively, the money would perhaps be better channelled into funding education and training to increase the mobility of workers and help them find employment elsewhere in the economy. While recent events in car markets can be interpreted as the functions of the market mechanism working to allocate resources efficiently, we have shown that there is a strong case for some sort of intervention, especially to encourage the transition from conventional engines to more environmentally friendly alternatives. ...read more.

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