1.4.1 Government Intervention Flashcards
What are the 4 main ways the government can intervene in the free market?
- indirect tax
- subsidy
- minimum price
- maximum price
What is an indirect tax?
A cost put on by the government that raises the costs of production
What does an indirect tax do to the negative externality diagram?
An indirect tax shifts the MPC to the left which in theory should bring it inline to the MSC eliminating the negative externality
Explain the analysis of an indirect tax being imposed on the negative externality
- indirect tax rises cost of production
- define market failure
- explain how the market failure occurs (1st party ect)
- such good is overconsumed and overproduced
- indirect tax shifts MPC
- reduces demand for such good
Evaluation points for the use of indirect tax to remove a negative externality
- underestimates or overestimates size of the tax
- elasticity of demand
- inflation pressures
- regressive
What is a subsidy?
A grant given by the government to lower the costs of production
What does a subsidy do to a positive externality diagram?
Shifts the MPB to the right in line with MSB
Explain the analysis of a subsidy being used to solve a positive externality
- define subsidy
- define market failure
- explain how the failure occurs (1st party)
- underconsumed and underproduced
- subsidy encourages production and consumption which shifts MPB right to MSB
- externality is removed
Evaluation points for a subsidy being used to remove a positive externality
- underestimate or overestimate size of subsidy
- conflict with govt polices
- opportunity cost
What is a maximum price?
A price legally imposed that suppliers cannot charge above
Where does the maximum price lay?
Below the equilibrium point
What does a maximum price solve?
Positive externality
What is the effect of a maximum price on suppliers?
A maximum price would cause a contraction along the supply curve to Qs. This means suppliers supply less due to the profit motive
What is the effect of a maximum price on consumers?
A maximum price causes an extension along the demand curve as people are willing to buy more.
What is the result of a maximum price?
Excess demand
What is a minimum price?
A price which is legally imposed at which the price cannot go below
Where does the minimum price sit on a demand and supply diagram?
Above the equilibrium point
What does a maximum price solve?
Negative externality
What does a minimum price do?
Raise the price, therefore consumers are deterred from consuming such product
What is the impact of a minimum price on suppliers?
There is an extension along the supply curve so producers are willing to supply more due to the profit motive
What is the impact of a minimum price on consumers?
There is a contraction along the demand curve, meaning people are less willing to consume the product
What does a minimum price result in?
Excess supply
Producers willing to supply more
Consumers willing to consume less
Evaluation points for maximum prices?
- depends on where the max price is
- PES of energy
- PED for energy
- government failure
- reduction of investment by suppliers
- loss of consumer surplus or higher prices in the future
Evaluation points for minimum prices?
Hidden markets
Must lay above the equilibrium point
