Government Intervention (Micro) Flashcards
(41 cards)
Main forms of government intervention in markets
- Price controls (price ceilings and price floors)
- Indirect taxes and subsidies
- Direct provision of services
- Command and control regulation and legislation
- Consumer nudges (HL only)
Reasons for government intervention in markets
- Earn government revenue
- Support firms
- Support households on low incomes
- Influence the level of production & consumption
- Correct market failure
- Promote equity (income distribution)
Types of taxes
- Direct tax
- Indirect tax / expenditure tax
- Specific tax / Unit tax
- Percentage tax / Ad valorem tax
Why do governments impose/reduce taxes?
- Generate tax revenue for the government
- Discourage consumption of a ‘harmful’ product
- Encourage consumption of ‘good’ product
- Income distribution
Evaluation of Taxation
Tax incidence - The impact/burden of a tax OR the amount which someone is made worse off by the tax.
This will be different depending on the elasticity of a good:
- Price inelastic = burden on consumer
- Price elastic = burden on producer
Subsidies
Subsidy - payment per unit of output from the government to a producer in order to lower costs or increase output.
Specific subsidy - also known as a ‘per-unit subsidy’; a specific amount is given for each unit of the product.
Why do governments give subsidies?
- Lower price of essential goods for domestic consumers = increasing consumption
- Guarantee supply of a product
- Enable producers to compete with overseas trade
- Encourage consumption of merit goods
Evaluating a subsidy
- Opportunity cost - government is not spending on other things
- Inefficiency of producers - support disrupts the free market.
- Even if consumers benefit from lower prices, they are paying for it in taxes (Taxpayers fund subsidies)
- Damage to sales of foreign producers - a big international debate (e.g. Agricultural goods)
Price Controls
When the government intervenes in a market and sets the price above or below the equilibrium price
Maximum Price (Price ceiling)
A maximum price, below the equilibrium price, set by the government for a particular good or service.
- Usually used to protect consumers
- Often used for merit goods, food shortages, or affordable housing for low-income groups.
Maximum Price (Price ceiling) CONSEQUENCES
Pros:
- Some consumers gain from lower prices → consumer surplus↑
- Can stabilize markets short-term (e.g. during Covid)
- Shortages mean some consumers miss out
Cons:
- Producers earn less → producer surplus↓
- Shortages may lead to black/grey markets
- Distorts market → inefficient resource allocation (e.g. rent caps)
- Gov’t may need to step in to meet excess demand in essential markets
Maximum Price (Price ceiling)
CONSEQUENCES FOR STAKEHOLDERS
Consumers: some gain, some lose
Producers: worse off as they sell less at a lower price, revenue falls
Workers: unemployment rises as production falls
Government: no gain, no loss, political popularity
Minimum Price (Price floor)
A minimum price set by the government for a good, above the equilibrium price.
- Usually used to protect producers
- Used to raise producer incomes or protect low-wage workers (e.g. minimum wage).
Minimum Price (Price floor) CONSEQUENCES
Pros:
- Producers benefit from higher prices; gov’t buys and stores/exports surplus
- In demerit markets, output drops as gov’t won’t buy surplus
- Output often lowered to match QD → reduces external costs
Cons:
- Gov’t purchases involve cost and opportunity cost
- Farmers may become reliant on gov’t support
- Lower output can lead to job losses in the sector
Minimum Price (Price floor) -
CONSEQUENCES FOR STAKEHOLDERS
Consumers: worse off as they pay a high price and can buy less
Producers: gain as they receive a higher price and produce more, revenue increases as government will buy the surplus
Workers: gain as employment rises
Government: loses as budget burdened
Minimum Wage - CONSEQUENCES
Pros:
- Ensures minimum income for low-paid workers
- Higher incomes boost consumption
- Can motivate higher productivity
Cons:
- Raises firms’ production costs → possible price hikes
- If prices can’t rise, may lead to layoffs/unemployment
Minimum Wage -
CONSEQUENCES FOR STAKEHOLDERS
- Firms: worse off as costs rise
- Workers: some benefit as they get high wages, others lose jobs
- Consumers: worse off as supply falls, prices rise.
Regulation and Legislation
Establishment of requirements and standards to regulate behaviour.
Pros of Regislation
- Solve the inefficiencies caused due to the fail of voluntary compliances.
- Can quickly reduce risks to public welfare.
INDIRECT TAX DIAGRAM
SUBSIDY DIAGRAM
PRICE FLOOR DIAGRAM
PRICE CEILING DIAGRAM
Consumer and Producer Surplus with Subsidies - Welfare Loss
