Government Intervention (Micro) Flashcards
Types of Government Intervention in Microeconomics
- Taxes
- Subsidies
- Price Controls (Minimum and Maximum Price)
Taxes
Types of taxes:
Direct tax - a tax on income
Indirect tax / expenditure tax - a tax on goods and services
Specific tax / Unit tax - a fixed amount of tax imposed on a product. E.g. $1 per unit. EXAMPLE GOOD: cigarettes
Percentage tax / Ad valorem 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
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 (e.g. milk), therefore increasing consumption
- Guarantee supply of a product that government sees as necessary to the economy either because it is a basic food supply for consumers or it is an important industry for employment (e.g. Agriculture, Coal)
- Enable producers to compete with overseas trade (protectionism)
- To encourage consumption of goods the government sees as positive for society (e.g. Electric cars)
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.
The Market Mechanism ensures:
Productive/Technical efficiency - where each firm pursues the least cost method of production (driving down average costs to a minimum)
Allocative efficiency - where firms produce goods that directly satisfy wants (so that price = marginal cost) and where resources are allocated into their best possible use. (Also known as Economic efficiency)
However, at times the market fails to allocate prices at a social optimum and the government may choose to intervene by setting price controls.
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 (a good that would be underprovided if the market were allowed to operate freely) or when there are food shortages (in order to ensure low cost food for the poor) 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, such as agricultural products (due to price fluctuations or foreign competition), 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
- 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.
- 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
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
