08. Methods of Government Intervention In Markets

Question 1

Why do governments intervene in markets?

Answer 1

1. To help consumers make better choices.
2. To promote sustainability.
3. To promote equity and economic well being.

Question 2

Define indirect tax.

Answer 2

• An indirect tax is one imposed upon expenditure.
• One of the reasons that governments impose indirect taxes is to provide the government with the revenues needed to carry out their many responsibilities.
• Another reason for setting taxes is to discourage the consumption of certain goods.

Question 3

What is a specific tax?

Answer 3

This is a specific, or fixed, amount of tax that is imposed upon a product; for example, a tax of $1 per unit. It thus has the effect of shifting the supply curve vertically upwards by the amount of tax, in this case, by $1. (S + tax)

Question 4

What is a percentage tax?

Answer 4

(Also known as ad valorem tax)
This is where the tax is a percentage of the selling price and so the supply curve will shift to the right, not uniformly. It is clear that the price between S and S+tax will get bigger as the price increases.

Question 5

What is a subsidy?

Answer 5

• A subsidy is an amount of money paid by the government to a firm, per unit of output.
• Subsidies can be direct cash payments or other assistance like low-cost or interest-free loans (for example student loans).
• Those subsidies consisting of payments by the government to firms, are usually a fixed amount per unit of output, and are called specific subsidies.

Question 6

Why might governments grant subsidies?

Answer 6

1. To support domestic firms (agriculture), to “revive” struggling industries, to be more competitive against foreign producers.
2. To make certain products cheaper for consumers (equity/fairness)
3. To incentivise productions of certain goods (good for people’s health).
   (4. To protect infant industries, diversify economy.)

Question 7

Who is affected by subsidies?

Answer 7

• Consumers.
• Producers.
• Government.
• Workers.
• Society as a whole.
• Foreign producers.

Question 8

How are consumers affected?

Answer 8

Consumers are affected by the fall in the price of a good and the increase in quantity consumed. Both changes make consumers better off.

Question 9

How are producers affected?

Answer 9

Producers receive a higher price and produce a larger quantity. This increases firms’ revenues.

Question 10

How is the government affected?

Answer 10

The government pays the subsidy, so it is a burden on its budget. It may have to cut spending elsewhere, raise taxes, or borrow money. Whatever the case, the impact on the government’s budget is negative.

Question 11

How are workers affected?

Answer 11

As output increases, firms are likely to hire more workers to produce the extra output. Workers who find new jobs are better off.

Question 12

How is the society as a whole affected?

Answer 12

• There is an over allocation of resources. So society as a whole is said to be worse off.
• Higher prices received by producers allows relatively inefficient producers to continue producing.
• The government funds used to pay for the subsidy have an opportunity cost. The funds paid by the government are greater than the total gains by the consumer and producer. This is known as the welfare loss

Question 13

How are foreign producers affected?

Answer 13

If the subsidy is granted on exports, it lowers price and increases the quantity of exports. While this is positive for domestic producers, it is negative for producers in other countries who are unable to compete with the lower price of the subsidised goods.

Question 14

What are price ceilings?

Answer 14

• Price ceilings (maximum prices) are usually put in place by governments to help consumers. They are usually imposed on necessities which may be under provided if the market was allowed to operate freely.
• For example, governments may set maximum prices for agricultural goods during times of food shortage to ensure affordable food, or they may set maximum prices on rented accommodation in order to ensure that everyone can afford a home.

Question 15

What is the problem with price ceilings?

Answer 15

They create excess demand, which is a problem. The shortages mat lead to the emergence of a black market, in which the products are sold at a higher price.
- The government may be forced to step in to eliminate, or at least reduce the shortage.
- The government may try to shift the demand line to the left, which defeats the purpose of imposing a price ceiling.
- The government can also intervene to shift the supply line to the right (increase supply). By (i) offering subsidies; (ii) direct provision; (iii) releasing stored goods onto the market if possible.

Question 16

What are price floors?

Answer 16

This is a situation where the government sets a minimum price, above the equilibrium price, which then prevents producers from reducing the price below it. These are sometimes known as floor prices, since they price is not able to go below “the floor” that has been put in place by the government.

Question 17

Why does the government add price floors?

Answer 17

• To raise the incomes for producers of goods and services that the government believes are important. Firms may receive help as their prices are subject to large fluctuations or lots of foreign competition. When equilibrium prices are low, producers may be harmed.
• To protect workers by setting a minimum wage, to ensure that workers earn enough to lead a reasonable existence. Very low equilibrium wages may be seen as unfair.
  (- To limit the amount of good being consumed (cigarettes))

Question 18

What are the problems of price floors?

Answer 18

Excess supply also creates problems. Producers will find that they have surpluses and will be tempted to get around the price controls to sell their surplus.
The government therefore has to buy up the surplus produce at the minimum price, shifting the demand curve to the right.
The government must then store the surplus, destroy it, or attempt to sell it abroad. Storage is expensive and often impractical. Selling abroad often creates bad relationships between nations as foreign governments accuse sellers of dumping products on their market and harming their own domestic producers.