2.7 Role Of Government In Microeconomics

Question 1

Why do governments intervene into markets?

Answer 1

• earn government revenue
• support firms
• support households on low incomes
• influence levels of production by firms
• influence the level of consumption by consumers
• correct market failure
• promote equity

Question 2

Main forms of government intervening in the market

Answer 2

• price ceiling
• price floor
• indirect taxes
• subsidy

Question 3

What are price controls

Answer 3

The setting of minimum or maximum prices by the goverment

Question 4

What is a price ceiling and draw the graph

Answer 4

Is a maximum price set below the equilibrium price, in order to make goods more affordable to people on low incomes

Question 5

Consequences of price ceiling for markets

Answer 5

• shortages - not enough of the good being supplied
• non-price rationing - once shortages occur price mechanism no longer achieves its rationing function, so non-price rationing methods occur e.x waiting in line, favoritism
• underground markets - illegally selling good above legal maximum as since shortages are present consumers are willing to pay more to get it
• under allocation of resources and allocative inefficiency - not enough resources are allocated to production of the good, society is worse off due to underallocation and allocative inefficiency
• negative welfare impacts - MB > MC, creating welfare los and allocative inefficiency

Question 6

Consequences of price ceiling for stakeholders

Answer 6

• Consumers - partly gain and partly lose as consumers who are able to buy the goof purchase it at a lower prices however some consumers remain unsatisfied since they cannot purchase the food
• producers - worse off, as they sell a smaller quantity at lower prices and revenue drops
• workers - fall in output means some workers likely to be fired, resulting in unemployment
• government - no gains or losses for the government budget

Question 7

Example of price ceiling

Answer 7

• rent controls - maximum legal rent on housing to make it more affordable
• food controls - method to make food more affordable to low income earners

Question 8

What is a price floor and draw the graph for it

Answer 8

A minimum price set above the equilibrium price, in order to produce income support to farmers or to increase wages of low-skilled workers

Question 9

Consequences of price floor for markets

Answer 9

• surpluses - excess supply, leading to government purchasing the excess supply
• government measures to dispose of surpluses - can store purchased supply or export the surplus
• firm inefficiency - firms with high costs of production do not face incentives to cut costs as high prices offer them protection against lower-cost competitors
• over allocation of resources and allocative inefficiency
• negative welfare impacts - MB < MC, surplus, allocative inefficiency due to over allocation, creating welfare loss

Question 10

Consequences of price floor for stakeholders

Answer 10

Consumers - worse off as they pay a higher price

Producers - gain as they receive higher prices , and since goverment purchases surplus, revenue increases

Workers - likely gain as employment increases due to greater production

Government - lose, buying excess supply is a burden on budget

Question 11

What is Indirect taxes and the graph for it

Answer 11

imposed on spending to buy goods and services

Question 12

Types of indirect taxes

Answer 12

• excise taxes
• Sales taxes

Question 13

Why do government impose taxes

Answer 13

• source of government revenue
• method to discourage consumption of goods that are harmful for individual
• used to redistribute income - e.x excise taxes focused on luxury goods
• improve the allocation of resources by correcting negative externalities

Question 14

Types of excise taxes

Answer 14

• specific tax - fixed amount of tax per unit of the good or service sold
• ad valorem taxes - fixed percentage of the price of the good or service

Question 15

Consequences of indirect taxes for stakeholders

Answer 15

• consumers - negatively affected due to higher prices
• producers - negatively affected due to fall in price they receive and the fall in quantity the sell
• the government - better off, as they earn revenue
• workers - worse off, lower amount of output means fewer workers needed
• society - worse off, due to underallocation of resources and decrease in social surplus

Question 16

What are subsidies and what does the graph look like

Answer 16

Assistance by the governments or individuals groups of individuals, such as firms, consumers, industries or sectors of an economy

Can take the from of direct cash payments or other forms of assistance such as low-interest loans

Question 17

Why do governments grant subsidies

Answer 17

• increase revenues of producers
• make certain goods (necessities) affordable to low-income consumers
• encourage production and consumption of merit goods
• support growth of particular industries in an economy
• encourage exports
• method to improve the allocation of resources by correcting positive externalities

Question 18

Subsidy impacts on stakeholders

Answer 18

Consumers - pay lower prices, better off

Producers - better off, as they lower production costs

Goverment - worse off, subsidy is burden on its budget

Workers - better off, more labour needed to produce extra output

Society - worse off, over allocation of resources, protects inefficient frims