government intervention in microeconomics

Question 1

Why do governments intervene?

Answer 1

• to correct market failure caused by externalities
• to support firms or consumers through the use of subsidies and price controls
• to control output of firms (quotas) and to improve sustainability
• to influence levels of consumption of demerit goods (nudges)
• to support low income household (benefits)
• to collect tax revenue (tariffs)
• to promote equality in income distribution (income tax)

Question 2

What is a price control?

Answer 2

setting of minimum or maximum prices which are determined by the government so that price can’t adjust to equilibrium levels determined by demand and supply
- often results in surpluses or shortages

Question 3

What is a price floor and how can it be seen on a graph?

Answer 3

maximum price set below the market equilibrium to make goods more affordable to those with low incomes

Question 4

What are consequences of a price floor?

Answer 4

• shortage of goods
• non-price rationing
• underground or parallel markets
• allocative efficiency isn’t achieved
• welfare loss

Question 5

How are different stakeholders affected by a price floor?

Answer 5

consumers - benefit to lower price, but face shortages
producers - total revenue and producer surplus decreases
workers - unemployment due to a fall in revenue
government - may gain political popularity

Question 6

What is a price celling and how can it be seen on a graph?

Answer 6

minimum price set above the equilibrium price to provide income and support low wage workers such as farmers

Question 7

What are consequences of a price ceiling?

Answer 7

• surplus of goods
• firm loses customers as they switch to cheaper substitutes

Question 8

How are different stakeholders affected by a price ceiling?

Answer 8

consumers - lose out as they have to pay a higher price
producers - total revenue increases and they are protected against lower cost firms
workers - gain employment due to increased production
government - cost to buy surplus supply, store it and grant subsidies

Question 9

What is consumer expenditure?

Answer 9

total revenue (price x quantity)

Question 10

How can community surplus be affected by price floors?

Answer 10

consumer surplus - decreases
producer surplus - increases

Question 11

How can community surplus be affected by price ceilings?

Answer 11

consumer surplus - increases
producer surplus - decreases

Question 12

What are indirect taxes?

Answer 12

taxes imposed to spending to buy goods or services; partly paid by consumers but are paid by the government to the producers

Question 13

What is excise tax?

Answer 13

taxes imposed on particular goods or services

Question 14

What is general sales tax?

Answer 14

tax on all goods or services to lower sales (VAT)

Question 15

Why does the government impose indirect taxes?

Answer 15

• source of government revenue
• discourage consumption of harmful goods
• to redistribute income
• to improve allocative efficiency
• to correct a negative externality

Question 16

What is per unit tax?

Answer 16

fixed amount tax

Question 17

What is ad valorem tax?

Answer 17

tax as a percentage of the value of the good

Question 18

What are the consequences on different stakeholders of indirect tax?

Answer 18

consumers - higher prices and lower quantity
producers - decreases in total revenue
government - gains revenue
workers - unemployment due to lower output

Question 19

How can indirect tax affect community surplus?

Answer 19

producer surplus - decreases
consumer surplus - decreases

Question 20

What are the advantages and disadvantages of indirect tax?

Answer 20

advantages - can eliminate welfare loss and create allocative efficiency
disadvantages - price may not deter consumption (depends on PED and PES)

Question 21

What is a subsidy?

Answer 21

amount of money paid by the government to firms to increase output for consumers as financial assistance - can be cash or policies
- increases price received by producers to encourage more production at a lower price to attract consumers

Question 22

Why do governments grant subsidies?

Answer 22

• to increase revenue for producers
• to correct market failure due to under-consumption of merit goods
• to make certain goods affordable for those with low incomes
• to encourage exports of a particular goods
• to switch away from goods with negative externalities
• to improve allocation of resources and overcome shortages

Question 23

What are the consequences on different stakeholders of subsidies?

Answer 23

consumers - purchase more goods at a lower price
producers - increased revenue and production as well as price received
government - cost to the government so has to reduce expenditure elsewhere
workers - increase employment to produce extra output
foreign producers - lower prices to compete with domestic producers

Question 24

What is the impact of subsidies on market outcomes?

Answer 24

1. increase quantity and lower price due to lower costs
2. price received by consumers increase
3. government spending on subsidy
4. over-allocation of resources

Question 25

What are the advantages and disadvantages of subsidies?

Answer 25

advantages - can overcome shortages and correct market failure
disadvantages - cost to taxpayer, welfare loss, opportunity cost

Question 26

What is the impact of subsidies on community surplus?

Answer 26

producer surplus - increases
consumer surplus - decreases