3.2 Methods and effects of government intervention in markets

Question 1

What is a maximum price?

Answer 1

The gov might set a maximum price where the consumption or production of a good is to be encouraged. This is so the good doesn’t become too expensive to produce or consume. They have to be set below the free market price.

Question 2

What is the purpose of maximum pricing?

Answer 2

It prevents monopolies from exploiting consumers. They control the market price, but this could lead to gov failure if they misjudge where the optimum market price should be. They can increase efficiency in firms as they have an incentive to keep their costs low to maintain profit level.

Question 3

What is the problem of maximum pricing?

Answer 3

It can reduce profits which may lead to less investment. It can also make firms raise the price of other goods which means consumers might not have any net gain.

Question 4

What is a minimum price?

Answer 4

The gov might set a minimum price where the consumption or production of a good is to be discouraged. This ensures the good never falls below a certain price. For example on alcohol or the national minimum wage. They have to be set above the market price otherwise they would be ineffective.

Also protects producers from price volatility

Question 5

What is the purpose of minimum pricing?

Answer 5

They should reduce negative externalities from consuming a demerit good.

Question 6

What is a direct tax?

Answer 6

They are paid directly to the gov from the taxpayer. This would be income tax, corporation tax, and National Insurance contributions

Question 7

What is an indirect tax? and why are they used?

Answer 7

They are used to raise gov revenue and also to solve market failures

It is an expenditure tax that increases cost of prodduction for a firm but can be transferred to consumers via higher prices

They are imposed by the government and they increase production costs for producers. Thus, producers supply less which increases the market price and demand contracts.

Question 8

What are the 2 types of indirect tax and what do they do?

Answer 8

Ad valorem tax - this is when tax increases as the amount sold increases (VAT). These are %’s. Looks like a V
Specific taxes - The tax is the same fixed amount at all prices. It is a set tax per unit. Vertical distance between the 2 supply curves represents the value of the tax.

Question 9

How specific tax looks on a graph?

Answer 9

IT is a parallel shift of the supply curve. When demand is perfectly inelastic or supply is perfectly elastic, the incidence of the tax falls fully on consumers.

Question 10

How does specific tax look with different PED’s?

Answer 10

If demand is more elastic, the incidence of the tax will fall mainly on the supplier
If demand is more inelastic, the incidence will fall mainly on the consumer

Question 11

How does an Ad Valorem tax look like on a graph?

Answer 11

It is a non-parallel shift of the supply curve. Like a V-shape.

Question 12

How does Ad Valorem tax look with different PED’S?

Answer 12

If demand is inelastic, gov revenue from the tax is higher than if demand is elastic. This is as demand will only fall slightly with the tax.

Question 13

What does internalising the externality mean?

Answer 13

This means the individual or firm which causes the negative externality will have to pay for the damage. However, it is very difficult to put a monetary value on the externality

Question 14

What is the average rate of tax?

Answer 14

This is the total tax paid divided by total income. It is a proportion of income. Increasing the average rate of tax as income rises means the tax is progressive.

Question 15

What is a flat tax?

Answer 15

This is when all people have to pay the same amount of tax

Question 16

What is a progressive tax?

Answer 16

This is when the average rate of tax increases as income increases. This should reduce inequality as those on low incomes pay less lax.

Question 17

What is a regressive tax?

Answer 17

This is when those on lower incomes have a larger average rate of tax. This leads to a less equitable distribution of income

Question 18

What is a subsidy?

Answer 18

It is a payment from the gov to a producer to lower their costs of production and encourage them to produce more
Solve market failure and increase affordability

Question 19

What do they look like on a graph?

Answer 19

They shift the supply curve right which lowers the market price. The vertical distance between the supply curves shows the value of the subsidy.

Question 20

How to calc gov subsidy?

Answer 20

It is the value of the subsidy x output

Question 21

What are the positive effects of subsidies?

Answer 21

They increase output and lower prices for consumers. Greater affordability
Huge positive for producers as revenue and profits sky high
They increase the employment rate by making workers more skilled through apprenticeship schemes and lowering the cost of employing workers.
They can help control inflation by keeping the price low.
They can help boost demand during periods of economic decline.
They can encourage the consumption of merit goods. LRAS could increase if the subsidy is aimed towards a capital project

Question 22

What are the negative effects of subsidies?

Answer 22

How will it be funded?
People may not use subsidies correct and be corrupt
There could be gov failure if the gov provides an inefficient subsidy or if it distorts the market price
Gov revenue could be spent elsewhere, the opportunity cost should be considered
It is usually the taxpayer who pays for the subsidy but they might not receive any direct benefit from it.

Question 23

How does PED of demand affect the subsidy to consumers and producers?

Answer 23

If demand is price inelastic, the subsidy will have a large effect on the equilibrium price. This gives a greater consumer gain than when demand is elastic
If demand is price elastic, the subsidy will have a larger effect on quantity and therefore benefit producers more.

Question 24

What is the state provision of public goods?

Answer 24

This is when the gov provides public goods that are under-provided in the free market such as health and education. This makes merit goods more accessible, which might increase their consumption and yield positive externalities. However, it could be expensive and there is an opportunity cost present when spending the revenue.

Question 25

What is the provision of information?

Answer 25

By providing info, govs can ensure there is no information failure, so consumers and firms can make informed economic decisions

Question 26

What is a buffer stock

Answer 26

Buffer stock is an additional volume of goods kept to meet any sudden future demand or supply fluctuations

Question 27

Indirect tax effect on consumers producers and government?

Answer 27

Raised price lowers consumer surplus. Lower choice as quantity decreases. Highly regressive as they take a larger % of lower income households. If demand is price inelastic, impact will be even greater.

Producers/ workers. Less producer surplus less producer revenue. With higher prices, Workers will lose jobs as labour is a derived demand and as quantity falls they won’t be required

Government like it as they might hit their 2 key goals. They solve market failures and gain revenue.
They wont like harm on consumers producers and all the unintended consequences. Regressive nature. Producers might leave country. Black markets might be created. DWL can be created too.

Question 28

Effects of minimum pricing on consumers producers and government

Answer 28

Consumers not fans because they pay higher prices and their consumer surplus is being eroded. Quantity choice and affordability is lower. Min prices effect is regressive as it takes more from LIC than rich people.
Over time they suffer as they have to bare the cost of intervention buying. Might be higher taxes or cuts of gov spending. Or maybe borrowed money which has det interest where there is a huge opp cost which can be used more productively in an economy instead.

Producers effect depends on whether there is interventionist buying If there is then there will be huge increase in rev and increase in producer surplus. Also they survive in a market if there is volatility as they are protected from all this

Gov like min prices if their core goals are being reached and they are keeping industries going and solving market failures.
Concerns of unintended consequences like black market but also the effects on consumers and also the funding costs. Also they are bearing the excess supply. What do they do with it? Maybe dump it overseas for lower than market price but that’s not allowed which leads to international relations approach

Question 29

effects of max pricing on consumers producers and government

Answer 29

Consumers benefit as long as they can access the market. Those who can buy at this lower price are loving it they are seeing greater affordability and CS and welfare is rising. However there is a large chunk of consumers who can’t access it and fall into the excess demand. They might be forced to alternative supplies like smuggling or black market for rented accom. Either long queues or waiting lists which isn’t desirable for consumers

Producers deffo not enjoying max price. Producer surplus and revenue falls. Lots of producers will supply something else and leave the market.

If gov hit their key goals, they will be happy however they will be very concerned about the impact on producers and them leaving which means contraction of supply. Also black markets etc. Might intervene to correct it and subsidise private firms to shift supply to equal demand. Comes a huge opportunity cost. Furthermore gov will be concerned about DWL.