Unit 2.7: Government Intervention

Question 1

Price ceilings

Answer 1

A legal maximum price that the government sets for a particular product

This is done when the government believes the prices are too high

E.g. rent for housing, or food

Question 2

Consequences of price ceilings for markets

Answer 2

1. Shortages - Qd >Qs
2. Non-price rationing - waiting in line first-come-first served. (Favouritism: selling goods to preferred customers)
3. Underground markets - Buying/selling transactions that are unrecorded, and usually illegal
4. Under allocation of resources to the good (allocative inefficiency)
5. Negative welfare impact (welfare loss)

Question 3

Direct taxes

Answer 3

Taxes imposed on income => reduces consumer income, leading to decrease in demand

Question 4

Indirect taxes

Answer 4

taxes imposed on expenditure => raises costs of producing the product, affecting supply

Question 5

(Indirect) Specific tax

Answer 5

A fixed amount of tax per unit of the good or service sold

e.g. $1 tax per unit

Question 6

(Indirect) Ad valorem

Answer 6

A fixed percentage of tax of the price of the good or service. The amount of tax increases as the price of the good or service increases

Question 7

Why do governments impose indirect taxes

Answer 7

• Collect government revenue
• Discourage consumption of demerit goods
• Redistribute income (taxed on luxury goods, affecting rich people)
• Reduce impact on society (productions causing pollution taxed)
• Correct negative externalities (if any allocative inefficiencies, it helps correct market failure and lead to allocative efficiency

Question 8

Subsidy

Answer 8

A fixed payment amount from the government to producers per unit of output.

Subsidies can also come in the form of assistance to individuals, firms, industries or sectors of an economy

Question 9

Why do governments impose subsidies?

Answer 9

• To increase revenues of producers. (e.g. agriculture)
• To make basic necessities more affordable to low-income consumers. (e.g. bread, rice)
• To encourage the consumption of a good or service which is considered desirable for consumers. (e.g. healthcare, vaccinations)
• To support growth of a particular industry.(e.g. renewable energy)
• To encourage exports and protect national industry from foreign competition. (cheap products that compete locally with imports and internationally with exports)
• To correct positive externalities, encourage production of merit goods.

Question 10

Why might the government intervene with a market?

Answer 10

1. Earn government revenue
2. Support firms
3. Support households on low incomes
4. Influence level of production for firms

Question 11

Purpose of price ceiling imposed by government

Answer 11

• Provide income support for farmers by offering market-determined prices (Product market)
• Protect low-skilled, low-wage workers by offering a minimum wage that is above market determined level (Resource market)

Question 12

Purpose of price floor

Answer 12

• Benefits producers: Typically set on agricultural products to ensure the income of farmers, particularly for crops that have very volatile prices
• Protects low-skilled, low wage workers: Offering a minimum wage that is above market-determined level

Question 13

Consequences of minimum wage

Answer 13

• Labour surplus and unemployment
• Illegal workers at wages below the minimum wage
• Misallocation of labour resources
• Misallocation in product markets.

Question 14

Minimum wage

Answer 14

Countries with minimum wage laws determine the minimum price of labour than an employer must pay

The objective is to guarantee an adequate income to low-income works, who tend to be unskilled

Question 15

Price Floors

Answer 15

A legal minimum price that the government sets for a particular product

This is done when the government believes the prices are too low

E.g. agricultural products and wages

Question 16

Consequences for price floors on markets

Answer 16

• Surpluses (Qs>Qd)
• Government measures to dispose of surpluses:
  1. Store it (incurs storage cost, in addition to purchase cost)
  2. Export the surplus
  3. Aid to developing countries
• Firm inefficiency - little incentive to cut costs
• Overallocation of resources to the production of the good and allocative inefficiency
• Negative welfare impact

Question 17

Consequences of minimum wage for the economy

Answer 17

• Labour surplus and unemployment
  More people willing to work, resulting in increased labour supply, yet an increased cost of hiring leads to a decreased demand for labour
• Illegal workers at wages below the minimum wage
  Often due to lack of choice and willingness to supply labour at very low wages
• Misallocation of labour resources
  Prevents market from establishing a market clearing price for labour. Especially given effect decrease in supply for unskilled workers
• Misallocation in product markets
  Firms relying heavily on unskilled workers experience an increase in cost of production. The misallocation of labour resources also results in misallocation in product markets

Question 18

Consequences of minimum wage for stakeholders

Answer 18

• Firms
  Increase in cost of production, thus are worse off
• Workers
  Some gain a higher wage than previously (Wm>We), others may lose their jobs (Qe-Qd)
• Consumers
  Increase in labour cost leads to a decrease in supply of products, increase prices

Question 19

Subsidies impact on stakeholders

Answer 19

• Consumers
  Pay lower prices for greater quantities, hence increase in consumer surplus
• Producers
  Receive higher price per unit and sell larger amounts of output. This increases total revenue, hence there is also an increase in producer surplus
• Workers
  Increase output leads to increased demand for labour. Employment and wages increase, ceteris paribus.
• Government
  Required to finance the subsidy expenditure. Oppurtunity costs arise from government expenditure