Government Intervention (Micro) Flashcards
Types of Government Intervention in Microeconomics
- Taxes
- Subsidies
- Price Controls (Minimum and Maximum Price)
Types of taxes
- Direct tax
- Indirect tax / expenditure tax
- Specific tax / Unit tax
- Percentage tax / Ad valorem tax
Why do governments impose/reduce taxes?
- Generate tax revenue for the government
- Discourage consumption of a ‘harmful’ product
- Encourage consumption of ‘good’ product
Evaluation of Taxation
Tax incidence - The impact/burden of a tax OR the amount which someone is made worse off by the tax.
This will be different depending on the elasticity of a good:
Price inelastic good – the burden is on the consumer
Price elastic good – the burden is on the producer
Subsidies
Subsidy - payment per unit of output from the government to a producer in order to lower costs or increase output.
Specific subsidy - also known as a ‘per-unit subsidy’; a specific amount is given for each unit of the product.
Why do governments give subsidies?
- Lower the price of essential goods for domestic consumers, therefore increasing consumption
- Guarantee supply of a product
- Enable producers to compete with overseas trade
- To encourage consumption of goods the government sees as positive for society
Evaluating a subsidy
- Opportunity cost - government is not spending on other things
- Inefficiency of producers - helping them to compete against foreign producers means it is no longer a ‘free market’
- Even if consumers benefit from lower prices, they are paying for it in taxes (Taxpayers fund subsidies)
- Damage to sales of foreign producers - a big international debate (e.g. Agricultural goods)
Price Controls
When the government intervenes in a market and sets the price above or below the equilibrium price
Maximum Price (Price ceiling)
Sets price below the equilibrium, leading to a shortage or excess demand
- Usually used to protect consumers
- Often put in place for merit goods or when there are food shortages or to ensure affordable accommodation for those on low incomes.
Maximum Price (Price ceiling) CONSEQUENCES
- Shortage
- Black market/parallel market/underground market (illegal market) (e.g. ticket scalpers)
- Queues and unfair systems
- Producers may start to decide who is allowed to buy
- Non-price rationing (waiting in line/first come first served, coupon distribution, sell to preferred customers)
- Allocative inefficiency
- Welfare loss
Maximum Price (Price ceiling)
CONSEQUENCES FOR STAKEHOLDERS
Consumers: some gain, some lose
Producers: worse off as they sell less at a lower price, revenue falls
Workers: unemployment rises as production falls
Government: no gain, no loss, political popularity
Minimum Price (Price floor)
Sets price above the equilibrium, leading to a excess supply.
- Usually used to protect producers
- Often put in place to raise incomes for producers that the government thinks are important, or to protect low skilled, low wage workers (minimum wage).
Minimum Price (Price floor) CONSEQUENCES
- Increase in firm inefficiency – protectionism
- Overallocation of resources
- Allocative inefficiency
- Welfare loss
- Negative welfare impacts (demand is less than supply), deadweight loss of welfare, consumers suffer and government has to spend more
Minimum Price (Price floor) -
CONSEQUENCES FOR STAKEHOLDERS
Consumers: worse off as they pay a high price and can buy less
Producers: gain as they receive a higher price and produce more, revenue increases as government will buy the surplus
Workers: gain as employment rises
Government: loses as budget burdened
Solving a price floor
- Purchase the surplus (storage is expensive)
- Destroy the surplus (wasteful, immoral)
- Use food colouring so that the food cannot be eaten by human and used for animals
- Buffer stock schemes
- Give the surplus as food aid to LDCS (undermines their producers)
- Sell abroad (if below market price this is known as dumping)
- Give producers quotas
- Leave it on the market - the price mechanism will auction off the surplus and the price will fall. In order to maintain a minimum price, a government MUST intervene in the market and purchase the surplus.
Minimum Wage - CONSEQUENCES
- Labour surplus and unemployment
- Workers are employed illegally
- Misallocation of labour resources as industries employing unskilled workers pay more and unskilled workers lose jobs
- Misallocation in the product market as costs rise, production/supply falls
- Negative welfare effects as unemployment rises due to less hiring
INDIRECT TAX DIAGRAM
SUBSIDY DIAGRAM
PRICE FLOOR DIAGRAM
PRICE CEILING DIAGRAM
Consumer and Producer Surplus with Subsidies - Welfare Loss
Government Revenue - Tax
Producer Revenue - Tax
Tax Burden
Tax Burden based on Elasticities
Revenue Changes in Subsidies
Change in Consumer Expenditure
Change in Government Spending for Subsidy
HL - Calculating effect on price ceiling
HL - Calculating effect on price floor
Ad verlorem/percentage tax
- Tax is a percentage of the selling price
- Its shift of the supply curve is not parallel
- The gap will get bigger as the price of the product rises. EXAMPLE: VAT, GST, Mehrwertsteuer, sales tax
