2.7 role of govt. in micro Flashcards
ways govt can intervene (6)
- price controls
- indirect taxes
- subsidies
- direct provision of services
- command and control regulation and legislation
- consumer nudges
why does govt intervene?
- To earn government revenue
- To support firms
- To support households on low incomes
- To influence the level of production
- To influence the level of consumption
- To correct market failure
- To promote equity
GST
goods and services tax
Also called value added tax. A tax on goods and services at every point or stage in the production process where value is added.
indirect tax
A tax imposed on a good or service; it is typically paid to the government by the producer or supplier and is considered a cost of production.
why does govt tax teh consumption of goods and services?
to raise govt. rev.
how does govt support firms?
through subsidies
RWE: The Common Agricultural Policy (CAP) of the European Union supports farming in member states by providing ‘direct payments’ to farming sectors in order to help support jobs and growth, modernise the industry and improve sustainability. In economics, we call this kind of support a subsidy . For example, the CAP planned to invest about EUR 63 billion in France’s farming sector and rural areas between 2014 and 2020 (European Commission, 2016). To give you an idea of how important these payments are, the CAP subsidy was used to:
- support more than 22 000 young farmers.
modernise over 30 000 farms.
The Common Agricultural Policy (CAP) of the European Union supports farming in member states by providing ‘direct payments’ to farming sectors in order to help support jobs and growth, modernise the industry and improve sustainability. In economics, we call this kind of support a subsidy . For example, the CAP planned to invest about EUR 63 billion in France’s farming sector and rural areas between 2014 and 2020 (European Commission, 2016). To give you an idea of how important these payments are, the CAP subsidy was used to: - support more than 22 000 young farmers.
modernise over 30 000 farms.
support more than 109 000 farms in less favoured areas (in mountain areas or with other natural constraints). - The Common Agricultural Policy (CAP) of the European Union supports farming in member states by providing ‘direct payments’ to farming sectors in order to help support jobs and growth, modernise the industry and improve sustainability. In economics, we call this kind of support a subsidy . For example, the CAP planned to invest about EUR 63 billion in France’s farming sector and rural areas between 2014 and 2020 (European Commission, 2016). To give you an idea of how important these payments are, the CAP subsidy was used to:
- support more than 22 000 young farmers.
- modernise over 30 000 farms.
- support more than 109 000 farms in less favoured areas (in mountain areas or with other natural constraints).
- Support more than 95 000 farms under the agri-environmental measures
RWE of govt supporting households w low income
Indonesia has had fuel subsidies in place since the country gained its independence in 1949. They are primarily designed to support people on lower incomes to afford fuel for their cars, mopeds, and other fuel-reliant equipment. The Indonesian government plans to spend IDR 137.5 trillion (USD 9.7 billion) on energy subsidies in 2020, compared with the IDR 142.6 trillion it spent in 2019 (Jakarta Globe, 2019). During the 1960s Indonesia’s fuel subsidies cost the government more than 20 per cent of its annual budget.
These fuel subsidies are controversial because they do not improve sustainability in the country, particularly in the capital, Jakarta, which suffers badly from pollution. In addition, because the subsidy is universally applied, the wealthy, who have no problems paying for fuel for their luxury cars, also benefit from the lower fuel prices.
why does govt seek to influence level of production?
why
- production of some goods can have -ve effects on society -> discourage production
- inversely, +ve effects -> encourage
(idea of externality)
why does govt seek to influence level of consumption?
why
- discourage consumption of demerit goods as they have negative consequences on society (demerit goods)
- inversely, encourage merit goods
demerit goods
Goods that have negative effects when consumed and cause negative externalities of consumption.
merit goods
Goods that are beneficial to the individual and society as a whole, and are usually under-provided in a free market.
govt measures to reduce smoking
effective measures to help reduce smoking, including indirect taxes, support programmes to help people quit and legislation, such as age restrictions, bans on tobacco advertising, and smoking bans.
(ie non-price determinants of demand + taxes!!!!)
market failure
Occurs when markets are no longer allocatively efficient, and marginal social benefit does not equal marginal social cost.
how can govt correct mkt failure?
Governments can intervene to correct market failure by forcing producers and consumers to contribute financially (through taxes) to correcting the problem, or by legislating to reduce the harmful outputs over time. Governments can also improve the transparency and availability of information so that consumers can make better decisions about buying goods that might have a negative effect on the environment or that might be harmful to themselves and/or others.
aims of price ceiling
- increase consumption of the good or service.
- reduce the price of certain goods or services for low-income consumers.
- prevent exploitation by monopolies (monopolies are covered in subtopic 2.11
two common situations where price ceilings used
- low-cost for low income earners
- affordable housing for low-income families
maximum price controls
Price ceiling set by the government that are set below the equilibrium price.
equilibrium price
The price that is set by the interaction between consumers and producers in markets where there are no surpluses or shortages and the market has cleared.
explain how price ceiling causes shortages
lower price -> more v willing and able to consume a greater amount, however producers willing and able to supply less -> excess demand ->shortage
-> consumption fall though consumers pay lower price
consequences of price ceiling (5)
- It produces shortages.
- It generates a rationing problem.
- It promotes the creation of parallel (black) markets.
- It eliminates allocative efficiency and generates welfare loss.
- There are consequences for market stakeholders
how does price ceiling cause a rationing problem?
shortage -> not all interested consumers will be able to purchase good -> problem of howwho gets to consumer the good and how to ration the available amount.
-> non-price rationing methods have to be used
non- price rationing methods (2)
When shortages result from price ceilings, the good or service will need to be allocated in a different way than by using the price
methods
- People line up and wait their turn to buy the good, and only those who arrive first will be able to do so.
- Coupons are distributed between the interested buyers so that they can purchase a fixed amount of the good in a given time period.
- sellers use favouritism to choose who they sell goods to
how does price ceiling promote the creation of parallel (black)markets?
many consumers who were willing and able to purchase the good at a higher price than the one set by the government will not be able to purchase the good through the legal market because of the shortage produced by the maximum price. At the same time, many producers who could have sold more units of the good at a higher price than Pmax before setting the price control will not be able to sell that higher amount through the legal market either.
This creates motivation for a black market for the good to emerge. Producers will try to sell the extra units at a higher price than Pmax as there will be consumers willing to buy them. Then the real price for the product being sold and consumed would be somewhere between Pmax and PE. This means that governments would not accomplish either of the objectives of the maximum price control policy.
parallel market
aka black market
A market where buying and selling transactions are unrecorded, and are usually illegal.
how does price ceiling cause allocative inefficiency and generate welfare loss
smaller amount of the good is being produced and consumed than the socially optimal amount determined by market equilibrium -> under allocation of resources to the production of the good from society’s POV -> allocative inefficiency = society worse off = welfare loss(/deadweight loss)
(gta draw the diagram out man aw man)
(diagram identify consumer surplus and welfare/deadweight loss)
price ceiling consequences on market stakeholders (identify stakeholders+consequences)
Consumers: Some consumers of the good are better off and some are worse off. Those who get to buy the good at a lower price than before are better off. Those who do not get to consume it at any price at all because of shortages or rationing are worse off.
Producers: Producers now sell a smaller amount of the good than before (Q1 < Qe) and receive a lower price for it. Their total revenue falls after the price ceiling is imposed, therefore they are worse off.
Workers: As the size of the market is reduced and fewer units of the good are sold, it is probable that workers will be fired in this market and unemployment will increase. Thus, those workers will be worse off.
Government: Government does not have a revenue or a cost from this specific policy. However, it may gain political popularity from those consumers who get to consume the good at a lower price than before.
solutions to maximum price control consequences
main problem: excess demand or shortage of prod in mkt
as market outcome does not accomplish original objectives of the policy -> not fair to consumers
- grant subsidies to the producers to encourage them to increase supply by producing more of the good.
- increase supply by producing the shortfall quantity of the good itself to meet total demand.
- store some of the product (as long as it is not a perishable good) before setting the price ceiling, then increase supply when needed by releasing some of its stocks on to the market.
= supply shift leftwards = eliminate excess demand