2.7 govorment intervention Flashcards
Reasons for government intervention in markets
CORRECT MARKET FAILURE
- There is dead weight loss so the government intervenes to correct market failure.
EARN GOVERNMENT REVENUE
- The government needs money to provide essential services and public and merit goods.
PROMOTE EQUITY
- The government wants to reduce the opportunity gap between the rich and the poor.
how equity promotes
- laws to protect workers (minimum wages, health, and safety laws)
- laws to prevent monopolies from forming
- laws to prevent environmental damage.
SUPPORT FIRMS
- gov supports industries gov believes is good to remain competitive.
- they do this by
- providing subsidies and tax breaks
- limiting foreign competition until new firms are well established and are able to compete internationally
SUPPORT POORER HOUSEHOLDS
- Poverty impacts both the economy and individuals
- intervention through range redistribution policies such as progressive tax structure and welfare payments help reduce poverty.
How government intervenes
- Indirect taxes
- Price controls
- Direct provision, regulation and nudges
Indirect taxes types + definition
tax placed on the producer (his produced goods and/or services) which is then (partly) passed on to the consumer in a form of a higher price .
- Specfifc
- ad-valorem
- excise/sin tax
Indirect taxes have greater burden on low income households then high income
Ad- valorem tax
A tax that is a % of the purchasing price (value-added tax/ VAT)
- The higher the price of the good the greater the amount of tax paid to the gov.
- VAT gives significant revenue to the gov.
Specific tax
A fixed tax per unit of output(specific amount)
Diagram analysis
- the decrease in QD causes suppliers to have to lay off some workers
Evaluation of Indirect Tax
The impact of PED on Tax income
Aiming to maximize profits producers pass as much indirect tax as they can to consumers and pay the rest themselves.
Inelastic Demnad= Porudcers pass greater amount of tax onto consumers and pay the rest themselves
Elastic demand= Producers pass smaller amount to consumers and pay the rest of themselves.
Subsidies
an amount of money per unit of output paid by the government to a firm
subsidies are shared between consumers and producers is determined by PED of good
- producers keep some of subsidies and pass on the rest to consumers through lower prices.
why?
- to increase consumption of some good by lowering prices
- to support certain industries by helping with production costs
- to address balance of payments deficit by increasing export revenue
Advantages and Disadvantages of Subsidies
Price controls
Price Controls are a type of government intervention in markets to change the existing market price, by imposing a maximum price (price ceiling) or minimum price (price floor)
Price ceilings (max prices)
A price ceiling is a legal maximum price set by the government for a particular good or service, aiming to prevent prices from reaching levels that are considered unaffordable for consumers .
- under the equilibrium price
- gov use price ceiling to help consumers be able to pay for necessities by lowering prices of goods
diagram analysis Price celining
They create excess demand
- QD > QS (Shortage)
- consumers have to supply less due to law of supply while more consumers demand
Effects of price celings
SHORTAGE
- since price is belowe equilibirum (shortage occurs)
- QD>QS
RATIONING
- Consumers and producers use other means to determine who receives product
Methods include:
- gov-created ratio cards or vouchers (coupons)
DEACRESE MARKET SIZE
- Since less is supplied, producers will cut back on labor meaning is causes unemployment
INCREASED CONSUMER SURPLUS
- the trade off to decreasing price and having to supply is fewer overall consumers
ELLIMINATION OF ALLOCATIVE EFFICIENCY
- Allocative efficiency is achieved when MB=MC(a price ceiling eliminates this)
- society is not producing enough of good with price ceiling
- causes dead weight loss
- increases consumer surplus
- decreases producer surplus
EMERGENCE OF BLACK MARKET
- disequilibrium pressures suppliers to withhold output from formal market and instead sell it on informal/black market.
- they do this to meet excess demand by selling goods at higher prices then price celling.
Examples of price celing
- healthcare insurance
- taxi fares
- diapers and baby food
- certain presriptioned drugs
- rent control
Evluation of price celing
Price floors (Min prices)
the lowest possible price set by the government that producers are allowed to charge consumers for the good/service produced/provided .
- It is abave equilibrium prices
Effects of price floors
SURPLUS
- since it is above equilbirum price it causes surplus
- QS>QD
REDUCES MARKET SIZE
- reduces market size becuase there is less demand
ALLOCATIVE INFEFFICIENTLY
-When QS>QD the MC producers face is higher then the MB that consumers derive from last unit of good purchased.
- Resources are overallocatied to price controlled good because cost of producing las unit of output exceeds value consumer places on it.
INFORMAL MARKET
Ouput that remains unsold can be: - - - bough by gov but if that doens happen then:
- it can be disposed (such as milk or non-lastin products)
- sold on the black market (prices will tend to be lower then price floors)
Examples of price floors
Minimum wage
Price floors in labour market
price floors protect workers from wage exploration
- a national min wage is imposed
min wage has winner and losers
WINNERS OF MIN WAGE
- workers that find jobs and binding min wage are better off then without min wage (they have more disposable income, enjoy higher quantity of life)
- due to higher wages some may say it increases demand since they spend more on the circular flow such as rent, food, consumer goods
- can create more employment opportunities
LOSERS OF MIN WAGE
- higher unemployment
- producers are worse off:
- wages are the resources of costs of labor
- resulting in higher prices, less output and reduced profits
-consuemrs in affected industry are worse off
-redcuded supply drives up prices and min wagehave increased production costs
- higher prices mean less QD and less consumer surplus
There are no clear winners and losers
- some products are better off then others.
Direct provision of services
Mnay goods/ services improve the lives of society (vaccine, health care, etc)
- this means gov pays for the entire production cost of good
Regulation and legislation
Legislation= process of creating laws
regualtion= proccess of monorting and enforcing laws
- ise of legislation and regulation, are referred to as command and control as it includes ongoing gov intervention
Gov intervention nudge theory
Gov intervens using consumer nidge theory to influence behaviour and choices without strict regulation
- consumer nudges are made to guide people without removing freedom of choice
- based on behavioral economics
examplkes of nudges
