#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 are the market outcomes when an indirect tax is imposed?
Equilibrium quantity falls from Q* to Qt.
Price paid by consumers rises to Pc.
Price received by producers falls to Pp (Pc - tax per unit).
Government revenue is the shaded rectangle (tax per unit × Qt).
There is underallocation of resources, as Qt < Q*.
Surpluses and Government Revenue (Post-Tax)
(govt revenue + consumer expenditure)
Consumer Surplus: Area above Pc, below the demand curve, up to Qt.
Producer Surplus: Area below Pp, above the initial supply curve (S1), up to Qt.
Government Revenue: Rectangle between Pc and Pp, up to Qt.
Welfare Loss (a + b): The lost surplus due to underproduction (Qt < Q*).
Consumer expenditure: Pricepaidbyconsumers(Pc)×Quantityconsumed(Qt).
What are the market outcomes of a subsidy?
Quantity Increases: From Q* to Qsb.
Price Paid by Consumers (Pc): Falls from P* to Pc.
Price Received by Producers (Pp): Rises from P* to Pp.
Government Spending: (Pp - Pc) × Qsb (entire shaded area).
Overallocation of Resources: Overproduction occurs (Qsb > Q*).
