#4 Govt Intervention Flashcards
Define price controls
“Price controls involve setting a minimum or maximum price by the government or private organizations, preventing prices from adjusting to their equilibrium level as determined by demand and supply. This intervention results in market disequilibrium, leading to either shortages (excess demand) or surpluses (excess supply).”
Why Do Governments Intervene in Markets + examples? (7)
Earn revenue (e.g., indirect taxes).
Support firms (e.g., subsidies, price floors).
**
Support low-income households*** (e.g., subsidies, price ceilings, transfer payments).
**Influence production **(e.g., subsidies increase production; taxes decrease it).
Influence consumption (e.g., discourage demerit goods via taxes; encourage merit goods via subsidies).
Correct market failure (e.g., through price controls, taxes, or direct provision).
Promote equity (e.g., income redistribution).
Define market failure.
Market failure occurs when the market fails to allocate resources efficiently,
producing quantities that are too large or too small relative to what is **socially desirable. **
Governments intervene to correct these inefficiencies using tools like taxes, subsidies, and price controls.
How does a price ceiling affect different stakeholders? And why
Consumers: Some gain (affordable prices), others lose (cannot purchase due to shortage).
Producers: Worse off (reduced revenue and quantity sold).
Workers: Job losses due to lower production.
Government: May gain popularity but faces enforcement costs.
What are the consequences of a price ceiling (5)
Consequences:
Shortage (demand > supply).
Non-price rationing (e.g., queues, favoritism).
Underground markets (illegal resale at higher prices).
Underallocation of resources to the good.
Negative welfare impacts (e.g., welfare loss).
Define welfare loss
Represents social surplus or welfare benefits that are lost to society because resources are not allocated efficiently
Underground/parallel markets
Involve buying/selling transactions that are unrecorded and usually illegal.
Underground markets in price ceilings (rationing)
“Underground markets involve purchasing a good at the maximum legal price and illegally reselling it at a price above the legal maximum. These markets often emerge when dissatisfied consumers, unable to purchase the good due to shortages, are willing to pay more than the ceiling price to obtain it. If there were no shortage, the price of the good would naturally settle at its equilibrium level, and no one would be willing to pay above it. Underground markets are inequitable and undermine the intended purpose of a price ceiling, which is to make the good affordable by setting a maximum price.”
what all is observed on the price ceiling diagram (7)
Equilibrium: At Pe, Qe (allocative efficiency).
Price Ceiling (Pc): Set below Pe (Pc < Pe).
Shortage: Qd > Qs (demand > supply).
Consumer Surplus: Increases (area a + c).
Producer Surplus: Decreases (area e).
Welfare Loss: Deadweight loss (areas b + d).
Allocative Inefficiency: Underproduction (Qs < Qe, MB > MC).
state all calculations after price ceiling
- CS / PS / W.L /
CS: a+c
PS: e
Welfare loss: c+ d
What is a price ceiling
A price ceiling is a legally set maximum price below the equilibrium price.
What is a price floor
A price floor is a legally set minimum price above the equilibrium price
In order to provide income support to farmers or to increase the wages of low-skilled workers
consequences of price floor (4)
Surplus (supply > demand).
Government purchases surplus, incurring storage/export costs.
Inefficiency (protects inefficient producers).
Negative welfare impacts (e.g., deadweight loss).
in terms of the graph state the points
At Pe, the equilibrium price, the quantity supplied equals quantity demanded (Qe).
The price floor is set above equilibrium (Pf > Pe) to protect producers.
Surplus = Qs - Qd.
CS decreases by b
PS increases by b+f
Govt: Pf
calculations after price floor
CS: a
PS: b+c+F
W.L: d+ g
Government cost: f+g
How does a minimum wage cause misallocation of labour resources?
A minimum wage disrupts the market-clearing price of labour, preventing the efficient allocation of resources. It affects industries that rely heavily on unskilled labour, as higher costs reduce hiring and discourage the use of unskilled workers.
What happens when a fixed price is set below the equilibrium in a high-demand scenario?
How does a minimum wage cause misallocation in product markets?
Firms that rely heavily on unskilled labour face higher production costs due to the minimum wage, leading to a reduction in output. This results in smaller quantities of goods being produced and misallocation of resources in the product market.
What is price fixing,
Price fixing involves setting a fixed price (e.g., tickets) by an organizing body, which does not allow adjustment based on supply and demand. This is done to maintain consistent pricing but can result in shortages or surpluses.
What happens when a fixed price is set below the equilibrium in a high-demand scenario?
If the price is fixed at Px which is below the equilibrium price Pe
a shortage occurs where the quantity demanded exceeds the quantity supplied.
What happens when a fixed price is set above the equilibrium in a low-demand scenario?
If the price is fixed at Px which is above the equilibrium price Pe
a surplus occurs where the quantity supplied exceeds the quantity demanded.
What are indirect taxes + 2 types
Indirect taxes are taxes imposed on goods and services, paid by consumers but collected by producers (firms) and then passed to the government.
Excise Taxes: Specific goods like petrol, cigarettes, alcohol.
Taxes on Spending: General sales tax, value-added tax (VAT).
How do indirect taxes affect resource allocation?
Indirect taxes increase prices, reducing consumption of taxed goods and decreasing production by firms.
In markets with allocative efficiency: Indirect taxes disrupt efficiency by reducing quantity supplied and increasing prices, creating a deadweight loss or surplus.
In markets with allocative inefficiency: Indirect taxes can correct negative externalities (e.g., pollution), helping improve allocative efficiency by reallocating resources more effectively.
Policies like indirect taxes are context-dependent—they can harm efficient markets but help fix inefficient ones.
