2.7 role of govt. in micro

Question 1

ways govt can intervene (6)

Answer 1

• price controls
• indirect taxes
• subsidies
• direct provision of services
• command and control regulation and legislation
• consumer nudges

Question 2

why does govt intervene?

Answer 2

• To earn government revenue
• To support firms
• To support households on low incomes
• To influence the level of production
• To influence the level of consumption
• To correct market failure
• To promote equity

Question 3

GST

Answer 3

goods and services tax
Also called value added tax. A tax on goods and services at every point or stage in the production process where value is added.

Question 4

indirect tax

Answer 4

A tax imposed on a good or service; it is typically paid to the government by the producer or supplier and is considered a cost of production.

Question 5

why does govt tax teh consumption of goods and services?

Answer 5

to raise govt. rev.

Question 6

how does govt support firms?

Answer 6

through subsidies

RWE: The Common Agricultural Policy (CAP) of the European Union supports farming in member states by providing ‘direct payments’ to farming sectors in order to help support jobs and growth, modernise the industry and improve sustainability. In economics, we call this kind of support a subsidy . For example, the CAP planned to invest about EUR 63 billion in France’s farming sector and rural areas between 2014 and 2020 (European Commission, 2016). To give you an idea of how important these payments are, the CAP subsidy was used to:

• support more than 22 000 young farmers.
  modernise over 30 000 farms.
  The Common Agricultural Policy (CAP) of the European Union supports farming in member states by providing ‘direct payments’ to farming sectors in order to help support jobs and growth, modernise the industry and improve sustainability. In economics, we call this kind of support a subsidy . For example, the CAP planned to invest about EUR 63 billion in France’s farming sector and rural areas between 2014 and 2020 (European Commission, 2016). To give you an idea of how important these payments are, the CAP subsidy was used to:
• support more than 22 000 young farmers.
  modernise over 30 000 farms.
  support more than 109 000 farms in less favoured areas (in mountain areas or with other natural constraints).
• The Common Agricultural Policy (CAP) of the European Union supports farming in member states by providing ‘direct payments’ to farming sectors in order to help support jobs and growth, modernise the industry and improve sustainability. In economics, we call this kind of support a subsidy . For example, the CAP planned to invest about EUR 63 billion in France’s farming sector and rural areas between 2014 and 2020 (European Commission, 2016). To give you an idea of how important these payments are, the CAP subsidy was used to:
• support more than 22 000 young farmers.
• modernise over 30 000 farms.
• support more than 109 000 farms in less favoured areas (in mountain areas or with other natural constraints).
• Support more than 95 000 farms under the agri-environmental measures

Question 7

RWE of govt supporting households w low income

Answer 7

Indonesia has had fuel subsidies in place since the country gained its independence in 1949. They are primarily designed to support people on lower incomes to afford fuel for their cars, mopeds, and other fuel-reliant equipment. The Indonesian government plans to spend IDR 137.5 trillion (USD 9.7 billion) on energy subsidies in 2020, compared with the IDR 142.6 trillion it spent in 2019 (Jakarta Globe, 2019). During the 1960s Indonesia’s fuel subsidies cost the government more than 20 per cent of its annual budget.

These fuel subsidies are controversial because they do not improve sustainability in the country, particularly in the capital, Jakarta, which suffers badly from pollution. In addition, because the subsidy is universally applied, the wealthy, who have no problems paying for fuel for their luxury cars, also benefit from the lower fuel prices.

Question 8

why does govt seek to influence level of production?

Answer 8

why
- production of some goods can have -ve effects on society -> discourage production
- inversely, +ve effects -> encourage

(idea of externality)

Question 9

why does govt seek to influence level of consumption?

Answer 9

why
- discourage consumption of demerit goods as they have negative consequences on society (demerit goods)
- inversely, encourage merit goods

Question 10

demerit goods

Answer 10

Goods that have negative effects when consumed and cause negative externalities of consumption.

Question 11

merit goods

Answer 11

Goods that are beneficial to the individual and society as a whole, and are usually under-provided in a free market.

Question 12

govt measures to reduce smoking

Answer 12

effective measures to help reduce smoking, including indirect taxes, support programmes to help people quit and legislation, such as age restrictions, bans on tobacco advertising, and smoking bans.

(ie non-price determinants of demand + taxes!!!!)

Question 13

market failure

Answer 13

Occurs when markets are no longer allocatively efficient, and marginal social benefit does not equal marginal social cost.

Question 14

how can govt correct mkt failure?

Answer 14

Governments can intervene to correct market failure by forcing producers and consumers to contribute financially (through taxes) to correcting the problem, or by legislating to reduce the harmful outputs over time. Governments can also improve the transparency and availability of information so that consumers can make better decisions about buying goods that might have a negative effect on the environment or that might be harmful to themselves and/or others.

Question 15

aims of price ceiling

Answer 15

• increase consumption of the good or service.
• reduce the price of certain goods or services for low-income consumers.
• prevent exploitation by monopolies (monopolies are covered in subtopic 2.11

Question 16

two common situations where price ceilings used

Answer 16

• low-cost for low income earners
• affordable housing for low-income families

Question 17

maximum price controls

Answer 17

Price ceiling set by the government that are set below the equilibrium price.

Question 18

equilibrium price

Answer 18

The price that is set by the interaction between consumers and producers in markets where there are no surpluses or shortages and the market has cleared.

Question 19

explain how price ceiling causes shortages

Answer 19

lower price -> more v willing and able to consume a greater amount, however producers willing and able to supply less -> excess demand ->shortage

-> consumption fall though consumers pay lower price

Question 20

consequences of price ceiling (5)

Answer 20

• It produces shortages.
• It generates a rationing problem.
• It promotes the creation of parallel (black) markets.
• It eliminates allocative efficiency and generates welfare loss.
• There are consequences for market stakeholders

Question 21

how does price ceiling cause a rationing problem?

Answer 21

shortage -> not all interested consumers will be able to purchase good -> problem of howwho gets to consumer the good and how to ration the available amount.

-> non-price rationing methods have to be used

Question 22

non- price rationing methods (2)

Answer 22

When shortages result from price ceilings, the good or service will need to be allocated in a different way than by using the price

methods
- People line up and wait their turn to buy the good, and only those who arrive first will be able to do so.
- Coupons are distributed between the interested buyers so that they can purchase a fixed amount of the good in a given time period.
- sellers use favouritism to choose who they sell goods to

Question 23

how does price ceiling promote the creation of parallel (black)markets?

Answer 23

many consumers who were willing and able to purchase the good at a higher price than the one set by the government will not be able to purchase the good through the legal market because of the shortage produced by the maximum price. At the same time, many producers who could have sold more units of the good at a higher price than Pmax before setting the price control will not be able to sell that higher amount through the legal market either.

This creates motivation for a black market for the good to emerge. Producers will try to sell the extra units at a higher price than Pmax as there will be consumers willing to buy them. Then the real price for the product being sold and consumed would be somewhere between Pmax and PE. This means that governments would not accomplish either of the objectives of the maximum price control policy.

Question 24

parallel market

Answer 24

aka black market

A market where buying and selling transactions are unrecorded, and are usually illegal.

Question 25

how does price ceiling cause allocative inefficiency and generate welfare loss

Answer 25

smaller amount of the good is being produced and consumed than the socially optimal amount determined by market equilibrium -> under allocation of resources to the production of the good from society’s POV -> allocative inefficiency = society worse off = welfare loss(/deadweight loss)

(gta draw the diagram out man aw man)
(diagram identify consumer surplus and welfare/deadweight loss)

Question 26

price ceiling consequences on market stakeholders (identify stakeholders+consequences)

Answer 26

Consumers: Some consumers of the good are better off and some are worse off. Those who get to buy the good at a lower price than before are better off. Those who do not get to consume it at any price at all because of shortages or rationing are worse off.

Producers: Producers now sell a smaller amount of the good than before (Q1 < Qe) and receive a lower price for it. Their total revenue falls after the price ceiling is imposed, therefore they are worse off.

Workers: As the size of the market is reduced and fewer units of the good are sold, it is probable that workers will be fired in this market and unemployment will increase. Thus, those workers will be worse off.

Government: Government does not have a revenue or a cost from this specific policy. However, it may gain political popularity from those consumers who get to consume the good at a lower price than before.

Question 27

solutions to maximum price control consequences

Answer 27

main problem: excess demand or shortage of prod in mkt
as market outcome does not accomplish original objectives of the policy -> not fair to consumers

• grant subsidies to the producers to encourage them to increase supply by producing more of the good.
• increase supply by producing the shortfall quantity of the good itself to meet total demand.
• store some of the product (as long as it is not a perishable good) before setting the price ceiling, then increase supply when needed by releasing some of its stocks on to the market.

= supply shift leftwards = eliminate excess demand

Question 28

price floors

Answer 28

Price floors are minimum prices set by the government that are set above the equilibrium price.

= minimum price controls

Question 29

aims of price floor policies (2)

Answer 29

• to increase the income of producers of goods and services that the government considers important, such as agricultural products, which are subject to large price fluctuations or great foreign competition.
• to protect workers, by setting a minimum wage that ensures they earn enough to have a reasonable standard of living.

Question 30

results of price floor (if govt does not intervene further)

Answer 30

increased price = consumers less willing and able to consume
+ producers more willing and able to supply

= excess supply

If the government does not intervene further, then the original policy objective of protecting producers of corn by increasing their revenue might not be achieved. The price has increased, but only for those who are still willing and able to consume the good at the higher price, so the quantity sold has fallen. Whether or not setting a minimum price will increase the producers’ total revenue depends on which of the two effects – an increased price or decreased quantity demanded – has been stronger (this depends on the relative elasticity of demand).

Question 31

possible consequences of imposing price floor

Answer 31

• It produces surpluses.
• It promotes the creation of black markets.
• The government needs to dispose of the surplus.
• It might create firm inefficiency.
• It eliminates allocative efficiency and generates welfare loss.
• There are consequences for market stakeholders.

Question 32

how does price floor cause surplus?

Answer 32

quantity supplied&raquo_space;qty consumed
= surplus

If the price is kept at Pmin, there will be a quantity QE supplied by all the producers who would have produced the good at the previous price PE, plus an additional quantity supplied by all of the new entrants to the market attracted by the high price, who will not be able to sell it anymore.

Question 33

how does price floor cause (informal) black market

Answer 33

If producers cannot sell all of their goods at the regulated price Pmin, they may try to sell it at a lower price on the informal (or black) market. This practice is illegal and will go against the original objective of the policy by selling the good at a lower price nearer to the original equilibrium price.

Question 34

how does price floor cause waste?

Answer 34

govt buy surplus and
1. store -> add. cost
2. burn excess good
= waste

Question 35

why does govt buy surplus?

Answer 35

to shift demand curve outwards to new equilibrium quantity. this generates cost for govt

Question 36

what does govt do with surplus bought?

Answer 36

• store the good, which will generate additional costs.
• sell the surplus abroad (export). It may have to consider what price to sell it at, if it aims to make back the money spent buying the surplus initially and also ensure the price is competitive abroad. It would need to be careful to not be seen to ‘dump’ the surplus abroad and be accused of unfair trade practices.
• send the surplus as aid to developing countries, but this usually causes problems for these countries, by reducing the demand for locally produced goods and potentially damaging local businesses.
• burn the excess good, but burning food (as in this example) is seen as being extremely wasteful and unethical given that so many people in the world are starving.

Question 37

how does price floor cause firm inefficiency?

Answer 37

firms know that they will receive a higher price no matter how inefficient they are in their production process, they will not be motivated to reduce costs and use more efficient methods of production.

higher prices than the equilibrium price may lead to production inefficiency bc high prices protect the firms from lower-cost competitors(no substitution effect)

Question 38

how does price floor cause allocative inefficiency and welfare loss

Answer 38

1. As a greater amount of the good is produced, Q2, than the socially optimal amount determined by the market equilibrium, Qe, there is an over-allocation of resources to the production of the good from the society’s point of view. Allocative inefficiency causes the society to be worse off. (surplus)

As shown in Figure 3, with no price control the market equilibrium is set at the price Pe and the quantity Qe. Consumer surplus is equal to area A + B + C and producer surplus is equal to D + E.

When the price floor is set, consumers only consume the quantity Q1. Therefore, the consumer surplus is area A (all of the area below the demand curve and above the price paid by consumers, Pmin, for the units consumed). With no further government intervention the welfare loss is C + E.

If the government buys the excess supply, producer surplus is now B + C + D + E + F (all of the area above the supply curve and below the price received by producers, Pmin, for the units sold).

This means that the consumer plus producer surplus increases after the price control and government purchase of the excess supply, because producers gain the area B + C lost by consumers, in addition to F.

The government has a cost of Pmin × (Q2 – Q1), which is a loss of social welfare. Because part of this loss is compensated by the gain in producer surplus represented by F, the net deadweight loss for society is the yellow shaded area shown in Figure 4.

Question 39

how does price floor cause consequences for market stakeholders?

Answer 39

Consumers. Consumers of the good are worse off as they will now consume a smaller amount of the good at a higher price.

Producers. If the government purchases the surplus, producers will sell a greater amount of the good than before (Q2 > Qe) and receive a higher price for it. Their total revenue increases after the price floor is imposed, therefore they are better off. If the government does not purchase the surplus then producers sell a lower volume of the good at a higher price. It depends on the price elasticity of demand whether their revenue increases or falls.

Workers. As the size of the market increases, it is likely that more workers will be hired in this market and consequently employment will rise; therefore workers will be better off.

Government. If the government buys the surplus it will incur a cost and have less funds to spend on other public goods and services, which is an opportunity cost. Additionally, if it has to store the product the cost will be even higher.

Question 40

shortage

Answer 40

When the quantity demanded of a good is more than the quantity supplied; occurs when the price in the market is below the equilibrium price. Also known as excess demand.

demand - supply = shortage

Question 41

surplus

Answer 41

When the quantity demanded of a good is less than the quantity supplied; occurs when the price in the market is above the equilibrium price. Also known as excess supply.

supply - demand = surplus

Question 42

potential goals of indirect tax policy

Answer 42

• collect government revenue.
• discourage consumption of undesirable and/or dangerous goods.
• redistribute income within the population.
• correct negative externalities and socially inefficient allocation of resources.

Question 43

indirect tax

Answer 43

A tax imposed on a good or service; it is typically paid to the government by the producer or supplier and is considered a cost of production.

Question 44

excise tax

Answer 44

alternative name for indirect tax

taxes that aim to discourage the consumption of particular goods, such as tobacco, petrol and alcohol

Question 45

two types of indirect tax

Answer 45

specific tax: An indirect tax that is a flat value, rather than a percentage, added to the sale of a good, such as EUR 3. like 2 eur per can of beer kind of think

percentage tax or ad valorem tax:
An indirect tax that adds a percentage of the price to the sale of the good, such as 5%.

(figures are different: specific is linear shift of graph, ad valorem is shift and tilt upwards as price increase = increase tax as uses %)

Question 46

effect of tax on different stakeholders (4 stakeholders)

Answer 46

consumers: Consumer expenditure on the good changes from P* × Q* to Pc × Qt.

Consumers are worse off after the tax, because they end up paying a higher price (Pc > P) and consuming a smaller amount of the good (Qt < Q).

producers: Producer revenue falls from P* × Q* to Pp × Qt, where Pp = Pc – tax per unit.

Producers are worse off as they end up selling a smaller amount of the good (Qt < Q*) and receiving a lower final price (Pp < Pc) after paying the tax to the governmen

government: The government is now better off because it collects revenue from the tax, which can be used to spend on the provision of public goods and services or any other government expenditure. Government revenue is equal to (Pc – Pp) × Qt, which is the difference between the two supply curves at the new equilibrium level of output in the market.

While it looks like the government may be the only stakeholder who benefits from the tax, taxes are usually levied on goods that are deemed harmful for society, so others do gain from the reduction in the sale of those types of goods.

workers(employment): The market has become smaller, as fewer units of output are consumed and produced after the tax (Qt < Q*). If a lower amount of goods are sold then fewer workers are needed to produce them. Some workers might be fired and therefore the tax may lead to unemployment.

Workers are worse off if they become unemployed

Question 47

effects of indirect tax on consumer and producer surplus

Answer 47

(draw diagram and explain in reference)
equilibrium point moves =
1. consumer and
2. producer surplus decrease
tax distorts market outcome, reducing the qty produced such that its lower than socially optimal amount, assuming no xternalities. thus underallocation, allocative inefficiency
3. welfare/deadweight loss

Question 48

effect of indirect taxes on society as a whole

Answer 48

• if no free market equilibrium w no externality: socially optimal output is produced w/o got intervention = no need for the tax. if tax implemented -> market is distorted -> underallocation of resources to the production of good -> supply decrease lower than social optimal
• if got market externality = tax meant to achieve social obj(reduce consumption of demerit goods) or to solve market externality (externality of smoking)

This policy should be evaluated within the context of the objective or reason for setting this tax. For example, the reasons are often to achieve other social objectives or to solve market externalities.

However, assuming that free market equilibrium, with no government intervention, is the socially optimal amount of the good, in the absence of externalities, then society as a whole is worse off. This is because the imposition of the tax distorts the market, producing an under-allocation of resources to the production of this good.

Question 49

summary of effect of indirect tax on
1. price for consumers
2. equilibrium quantity
3. net price of producers
4. total rev of producers
5. total expenditure of consumers
6. govt rev
7. comm. surplus

Answer 49

1. increase
2. decreases
3. decreases
4. decreases
5. depends on PED
6. increases
7. increases

Question 50

calculating indirect tax

Answer 50

ad valorem tax = (PxQ) x %of tax
specific tax = Q x tax/Q

Question 51

subsidy

Answer 51

An amount of money paid by the government
to a firm, per unit of output, to encourage
production and lower the price to consumers.

Question 52

aims of subsidies (6)

Answer 52

• to increase revenues of producers.
• to make basic necessities and merit goods more affordable to low-income consumers.
• to encourage the consumption of a good or service that is considered beneficial to consumers.
• to support growth of a particular industry.
• to encourage exports and protect national industry from foreign competition.
• to correct positive externalities, improving the allocation of resources.

Question 53

effect of subsidies on market

Answer 53

producers are willing and able to supply a greater amount of to market = supply curve shift downwards(rightwards) = equilibrium price decreases -> by law of demand, consumers demand more

Question 54

effects of subsidies on different stakeholders (4 stakeholders)

Answer 54

consumers: better off after the subsidy because they pay a lower price (Pc < P) and consume a greater amount of the good (Qsb > Q).
producers: better off as they sell a greater amount of the good (Qsb > Q*) and receive a higher final price (Pp > Pc) after receiving the subsidy from the government.
government: The government is now worse off, as it has a cost because of the subsidy. The cost of the subsidy is equal to (Pp – Pc) × Qsb, which is the difference between the two supply curves at the new equilibrium level of output in the market.

The government has an opportunity cost as the funds granted in subsidies cannot be used to provide public goods and services or for any other government expenditure

employment: The market has become bigger because more units of output are consumed and produced after the subsidy (Qsb > Q*). If a greater amount of goods are sold, then more workers are needed to produce them. Therefore, the subsidy may lead to higher employment in this market.

Workers are better off if more people are employed.

Question 55

effect of subsidies on society as a whole

Answer 55

free mkt equilibrium where alr socially optimal w/o govt intervention: society worse off as
1. overallocation of resources to production of subsidies good
2. higher price received by producers = relatively inefficient producers can keep producing as they’re protected by subsidy = society worse off

Question 56

summary of effect of subsidies on:

1. price for consumers
2. equilibrium quantity
3. net price of producers
4. total rev of producers
5. total expenditure of consumers
6. govt rev
7. social welfare

Answer 56

1. decreases
2. increases
3. increases
4. increases
5. depends on PED
6. decreases
7. decreases

Question 57

calculate subsidies

Answer 57

qty x subsidy amount

Question 58

draw d-s diagram for subsidies incl:
1. consumer surplus
2. producer surplus
3. welfare loss

Answer 58

draw it i dare you

Question 59

direct provision of services (def+7e)

Answer 59

services that are directly provided by state
(thus can control supply and in turn, demand.)
examples:
- healthcare
- public transport
- rail networks
- telecommunications
- airlines
- education
- energy

Question 60

argument for and against direct provision of public services

Answer 60

for:
- are essential services -> profit should not be a motive + citizens have the right to access cheaply
- industries inherently uncompetitive = having multiple supplies does not work
- public services are natural monopolies (e.g. water supply or same train line operated by multiple companies?) competition doesn’t make sense for public services

against:
- privatised essential services promotes efficiency as have competition
- privately funded services more efficient = sooner production as less political debate, political hurdles and bureaucracy to overcome

example:

The Netherlands operates a privately funded health insurance system. People pay for their medical insurance instead of funding health care through taxes, and employers must also contribute. The insurance payments are capped and a person cannot be charged differently or be rejected from having insurance based on their health condition or needs. Hospitals and hospital groups are not for profit, compete with each other for patient care and are rated in terms of quality and patient satisfaction.

Question 61

regulation

Answer 61

Regulation is when governments monitor firms and industries to confirm that they are abiding by relevant legislation.

govt. dept. may be set up to regulate an industry, oversee particular sectors like edu, healthcare, agri.

Question 62

legislation

Answer 62

Laws enacted by governments to limit, prohibit, or require certain behaviours.

e.g. for all children to attend school till they’re a certain age. in order to demonstrate child participation, schools required register their students daily and report frequent absences to local authority or government. in some countries, parents can be fined if their children do not attend school regularly.

Question 63

what has been done to reduce smoking (ped inelastic)

Answer 63

• indirect taxes insufficient as PED inelastic = must increase prices drastically

command and control methods adopted by govt
- age restriction
- advertisement bans (not in media, packaging, hiding in shops)
- smoking bans in places = less socially acceptable

Question 64

how do we manage fish stock - overfishing

Answer 64

free market cannot efficiently allocate fish as a resource without causing probs for future gen -> caused y problem of scarcity

command control methods to resolve:
- using fish quota = limits amount of fish by weight/species
- banned fishing methods: bottom trawling-indiscriminate fishing, dynamite-inexpensive and effective in catching large volumes, cyanide-based chemical used to stun fish before catching->sell to aquarium/as pets
- managing marine conservation areas
- managing marine conservation areas-protect certain areas from fishing=give habitat chance to recover and replenish

Question 65

consumer nudges

Answer 65

Small design changes that include positive
reinforcement and indirect suggestions that can
influence the behaviour of consumers.

Question 66

basic principles employed by nudges

Answer 66

EAST
Easy
Attractive - visuals, clever marketing, perceived benefit
Social - see other doing too=doesn’t wna be left out
Timely - when are consumers likely to see and in what circumstances r they most likely to alter behaviour

Question 67

examples of consumer nudges

Answer 67

• Only placing healthy snacks at checkouts instead of junk food
• Plastic carrier bag charges
• Bottle deposit schemes
• Making organ donation an opt-out scheme rather than having to choose to opt-in
• Placing a target or image in the bowl of men’s urinals to improve hygiene.

Question 68

3 main methods of consumer nudges (3+def)

Answer 68

1. providing information - provided w certain info=act a certain way (e.g. traffic light symbols on food packaging=make healthier choices)
2. changing environment - change situation where they make choices=directed to desired choice (e.g. default options on websites, opt-out system for organ donation, healthy food at checkouts
3. using social norms - if people do they same thing=seek to emulate=motivated(e.g. statistics of electricity consumption=emulate=reduce)

Question 69

advantages and disadvantages of consumer nudges

Answer 69

+ve relatively inexpensive methods
-ve critics say manipulative and belittling