2.7 role of government (government intervention) Flashcards
purpose of indirect tax
- increasing tax revenue
- correcting market failure (negative externalities, demerit goods)
main forms of government intervention in markets [6]
1) Indirect taxes
2) Subsidies
3) Price control: price ceilings & price floors
4) Command and control regulation and legislation
5) Direct provision of goods and services
6) Nudges (HL only)
examples of the purposes of indirect tax
- increasing tax revenue
- e.g. onsen hot spring in Japan
- correcting market failure (negative externalities, demerit goods)
- e.g. discourage people from using indoor tanning services in US, risks of skin cancer from UV light exposure
- e.g. tax on junk food in Hungary
e.g. Bachelor tax in South Africa
indirect tax
tax imposed on spending (goods & services)
direct tax
tax imposed on income, profits and wealth
excise tax
an indirect tax on a specific good or service
specific tax
a fixed amount of tax per unit of good or service sold
Why does a supply curve shift upwards when as indirect tax is applied?
Indirect taxes are paid by the firm to the government
- Therefore, for every level of output the firm is willing to supply to the market, it must receive a price that is higher than the original price by the amount of tax
Ad Valorem tax
tax calculated as a fixed percentage of the price off the good or service
examples of excise tax in HK
- alcohol, petrol, cigarettes, for new cars only in general
- demerit goods, want to discourage consumption
why impose taxes?
1) Government revenue
2) Distribution of income
3) Correcting negative externalities to improve allocative efficiencies
- e.g. influencing level of production
- e.g. influencing level of consumption
is tax revenue a loss to society?
tax revenue is not a loss to society b/c tax revenue is reinvested into the economy in the form of welfare, education etc.
effect if indirect tax on stakeholders
- Consumers :(
- CS decrease → price increase & quantity decrease
- Producers :(
- PS decrease → price decrease & quantity decrease
- Workers :(
- Total revenue decrease ⇒ P1Q1 → P3Q2 → lower production → fire workers (lower COP)
- Government :)
- Tax revenue
- Society :(
- Deadweight loss, SS decrease due to dwl
what happens to the allocation of resources when an indirect tax is imposed
underallocation of resources
- the society is allocatively efficient when production is at Q0
- society is being worse off as less goods are produced at Q1
what is the assumption made about a good before government intervention
good before government intervention – is at allocative efficiency
Why is there a deadweight loss when the supply curve shifts to the left?
- Assumption → before government intervention, everything allocated most efficiently
- Q0 → allocative efficiency
- To measure allocative efficiency: look at the quantity
- In society: prefer Q0, but now only Q1 → underallocation of resources → misallocation of resources
subsidy
financial support to individuals or groups for reducing costs of production
purpose of subsidies [5]
- Increase producer revenue (e.g. agricultural products)
- Make necessities more affordable
- Encourage production and consumption of socially desirable/merit goods or services (correcting allocative efficiency) (e.g. vaccinations and education)
- Support the growth of particular industries (e.g. enterprise support scheme for R&D in HK)
- Encourage exports
consequence of subsidies to different stakeholders
Consumers :)
- Price decrease :), Quantity increase :) → CS increase
- CS area: abcgf (old CS: ab) (gain = cgf)
Producers :)
- Price increase :) (price they receive increases, P2+unit subsidy=P3), Quantity increase :) → PS increase
- PS area: bcdh = [hij+? (paralellogram)] (old: ch) (gain bd)
Foreign producers :(
- their prices may be higher than local prices → discouraging people from buying from foreign producers (price includes import fees as well)
- Not as competitive (as locally produced goods)
Workers :)
- Producer’s TR increase (b/c P3Q2 > P1Q1)
Government :(
- Sub expense (increased government expenditure)
- area: efgbdc (loss = bcdefg)
Society :(
- deadweight loss
- producers may become over reliant on subsidy → complacency
- not good for society → not at allocative efficiency
how to find dwl?
- gains from surpluses vs losses from surpluses
- gain does not exceed the cost by the government (subsidy)
what happens to the allocation of resources of the good when a subsidy is imposed?
there is an overallocation of resources
- The society is allocative
- The society is allocative efficient when production is at Q1
- Society is being worse off as too many goods are produced at Q2
price controls
government setting maximum (price ceiling) OR minimum (price floor) price on goods and services
price ceiling
below equilibrium price, bc equilibrium price too high
price floor: when P is too low
price floor
above equilibrium price, so producers can receive higher price (e.g. wage)
reduce people’s consumptions → Qd decrease → fix market failure
- price ceiling: when P is too high
tax creates a ___ equilibrium
new
subsidies creates a ___ equilibrium
new
price controls creates
market disequilibrium
effect of price ceiling on different stakeholders (with NYC 1947 rent control/price ceiling example)
- Consumers :(
- Price decrease :) , quantity decrease :( → CS is uncertain
- Enjoy cheaper houses (price decrease, P1→Pc), rich people abused the system, encourages illegal business activities (e.g. black market) ⇒ shortage
- e.g. bc quantity decrease, some people will bribe landlords to get the housing → creates a black market
- at Qs → rich politicians/celebrities → lucky people
- at Qd → other people → have to pay a higher price
- Producers :(
- Price decrease :(, quantity decrease :( → PS decrease
- Revenue decreases → production decreases + landlords ignore repairs → quaity of house decreases, encourages sub-divided houses
- compare P1Qs to P1Q1 → smaller
- Workers (construction) :(
- Production decreases → losing jobs
- generally same as producers (if producer :( workers also :( !!)
- Production decreases → losing jobs
- Government :/
- It depends: may get political popularity or not
- who would support the government? = rich people, people in Qs
- who would not support the government? = people in Qd
- Society :(
- Inefficiency → DWL
- consumers: misallocate resources to the black market
- producers: not allocating resources efficiently → decrease production and ignore repairs
- Inefficiency → DWL
consequence of price ceiling on the economy
- Shortage
- Non-price rationing
- e.g. lines, coupons, favouritism
- Underground (parallel) markets (i.e. black market)
- Welfare loss (allocative inefficiency → underallocation of resources)
What can the government do about the shortage? (i.e. of housing)
- increase supply → cause a shift
- can provide more housing
Why is there DWL?
- something will disrupt allocative efficiency (e.g. price ceiling)
- try to fix one problem caused by one government intervention with another government intervention
- causes DWL
- continuous cycle
stakeholders
are parties that have interest on the economic activities who can affect or be affected by the outcome of the economic activities
common reasons for price floor [2]
- Provide support for primary products (resource market)
- Protect low-skilled, low wage workers (labour market)
Why are farmers incomes often unstable and low?
- Low PED and PES (big price fluctuations) → inelastic
- Low YED (no big changes in consumption)
- Price floor creates a surplus :( — what can the governments do to the surplus in the case of agriculture products? (e..g milk, potato, wheats)
- governments can subsidise consumers
- governments can buy the surplus → government may buy the excess supply
Government measures to dispose of surplus (from price floor after they purchase the surplus)
- store the surplus
- export the surplus
- use as aid and send to developing countries
what is a problem created when the government tries to dispose of surplus?
other countries may see it as dumping → selling at low prices
consequences of government purchase (of surplus caused by price floor) to different stakeholders
- Consumers :/
- Producers :)
- b/c government buy surplus → quantity increase
- higher revenue
- Workers :)
- firm has higher revenue, possibly higher pay for workers
- Government :(
- higher government expenditure
- Foreign consumers :)
- cheaper prices
- Foreign producers :(
- reduced competitiveness due to higher prices
- dumping → goods being sold at low prices
direct provision of services
Many public goods and services improve the lives of a country’s population
Governments often provide services to improve the level of equity e.g. healthcare services ensure everyone can access the same medical treatment
what does state provision of public goods/services refer to?
Public goods are beneficial for society and are not provided by private firms due to the free rider problem
Examples include roads, parks, lighthouses, national defence
disadvantages of direct provision
Paid for through general taxation
There is an opportunity cost associated with their provision
Products which are free may result in excess demand and long waiting times e.g. procedures at Public hospitals
advantages of direct provision
They are usually provided free at the point of consumption
Accessible to everyone regardless of income
Usually provide both private and external benefits to society
legislation
Legislation is the process of creating laws
regulation
regulation is the process of monitoring and enforcing the laws
does legislation and regulation involve ongoing government intervention?
yes
The use of legislation and regulation are referred to as command and control as it involves ongoing government intervention
what does legislation and regulation involve?
Governments create rules (laws) to limit harm from the external costs of consumption/production
They often create regulatory agencies to monitor that the rules are not broken
advantages of legislation and regulation
Individuals or firms may be fined/imprisoned for breaking the rules e.g. selling cigarettes to minors is a punishable offence
They help to reduce the external costs of demerit goods
Fines can generate extra government revenue
disadvantages of legislation and regulation
Enforcing laws requires the government to hire more people to work for the regulatory agencies
Enforcing laws can be difficult as it is a complex process to determine if firms/consumers are breaking the laws
The regulation may create underground (illegal) markets which could generate even higher external costs on society
