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
Minimum Wage -
CONSEQUENCES FOR STAKEHOLDERS
- Firms: worse off as costs rise
- Workers: some benefit as they get high wages, others lose jobs
- Consumers: worse off as supply falls, prices rise.
Buffer Stocks
A buffer stock is where an organisation intervenes in an agricultural market in order to maintain prices
Problems with a buffer stock
- Can only be used for storable goods (e.g. sugar)
- Opportunity cost associated with storage costs
- Organization is spending funds to purchase food that it’s possible no one will ever consume
- Consequences include farmers moving into producing more of that good.
Reasons for government intervention in markets
Reasons for government intervention in markets include:
- Earn government revenue (e.g. taxes)
- Support firms (e.g. subsidy, price floor)
- Support households on low incomes (e.g. price maximum for rent)
- Influence the level of production (e.g. quota +next unit on market failure)
- Influence the level of consumption (next unit on market failure)
- Correct market failure (next unit on market failure)
- Promote equity (e.g. income tax policies → macroeconomics)
Main forms of government intervention in markets
- Price controls (price ceilings and price floors)
- Indirect taxes and subsidies
- Direct provision of services
- Command and control regulation and legislation
- Consumer nudges (HL only)
Solving a price ceiling
- Do nothing – allow the shortage to remain. However, this means that the very government policy put in place to solve homelessness will actually make the problem worse. The quantity of flats available will fall from Qe to Q1.
SUPPLY SOLUTIONS - Shift supply right (see next slide)
- Pay producers a subsidy
- Release previously stored stocks (stored goods) onto the market - only possible for non-perishable goods.
- Government becomes a producer (with opportunity cost)
OTHER
- Allocate the good using alternative means such as queuing, rationing or means testing.
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
Direct Tax
Tax on income
Indirect/Expenditure tax
Tax on goods and services
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
Specific tax / Unit tax
A fixed amount of tax imposed on a product
E.g. $1 per unit
Solving a price ceiling
- Pay producers a subsidy
- Release previously stored stocks (stored goods) onto the market - only possible for non-perishable goods.
- Government becomes a producer (with opportunity cost)
- Allocate the good using alternative means such as queuing, rationing or means testing
