Government Action in Markets pt 2 Flashcards
What are two examples of government intervention in markets?
- Production quotas
- Subsidies
What is a production quota?
An upper limit to the quantity of a good that may be produced in a specified period
What is the effect of a production quota below the equilibrium quantity?
- A decrease in supply
- A rise in price
- A decrease in marginal cost
- Inefficient underproduction
- An incentive to cheat and overproduce
Why does a production quota set below the equilibrium quantity cause a decrease in supply?
It decreases the supply of the good as it limits the amount produced. The total of the producer’s limits = quota. Any production in excess of the quota is illegal
Why does a production quota set below the equilibrium quantity cause a rise in price?
The quota decreases the supply of the good meaning there is a shortage causing price to rise
Why does a production quota set below the equilibrium quantity cause a decrease in marginal cost?
The production quota lowers the MC of producing the product as producers produce less and stop using the resources with the highest marginal cost, they reduce their supply and MC curves
Why does a production quota set below the equilibrium quantity cause inefficiency?
Quota = underproduction = MSB equal to price which has increased, MSC has decreased, MSB exceeds MSC causing deadweight loss to arise
Why is there an incentive to cheat when a quota is set below the equilibrium quantity?
With the quota, the price exceeds MC, so the producer can get a larger profit by producing one more unit, if all producers produce more than their given limit, the quota is ineffective
What effects do subsidies have?
- An increase in supply
- A fall in price and increase in quantity produced
- An increase in marginal cost
- Payments by governments to producers
- Inefficient overproduction
Why do subsidies set above the equilibrium level cause an increase in supply?
- Decrease in cost to produce the good
- Firms can afford to supply more
- New supply curve = minimum supply price - subsidy
Why is there a fall in price and increase in quantity produced when subsidies are set above the equilibrium level?
- Subsidy lowers the price of the product and increases the quantity produced
- Equilibrium occurs where the new supply curve intersects the demand curve
Why is there an increase in marginal cost when a subsidy is set above the equilibrium level?
- The subsidy lowers the price paid by consumers but increases the marginal cost of production
- MC increases because producer produce more products which means they must use some resources that are less ideal for production
Why are there payments made by governments to producers after a subsidy is introduced?
They pay a subsidy to producers on each ton of product produced causing the production level to increase
Why is there inefficient overproduction when a subsidy is introduced?
- MSC has increased exceeding the market price
- MSC exceeds MSB
- Domestic market price lower so will offer output to the rest of the world
- This global increase in supply causes price to fall
- Producers in other countries decrease production and receive smaller revenues
What is the nature of markets for illegal products e.g drugs?
- Cost of trading increases
- This increase depends on the penalties for violating the law and the degree of enforcement
- Penalties might be imposed on buyers or sellers or both
