Govt Intervention Flashcards
Possible reasons for govt inervention
- Earning govt revenue
- Supporting firms (domestic?), households on low incomes
- Influencing levels of production (limiting producer power?)
- Influencing levels of consumption (encouraging consumption of merit goods, discouraging consumption of demerit goods)
- Correcting market failure
- Promoting equity (redistribution of wealth)
Main forms of govt intervention
- Price controls (ceilings [max prices] and floors [min prices])
- Indirect taxes + subsidies
- Direct provision of services
- Command and control regulation + legislation
Price ceiling/cap
- Max price, set below the market price, that a seller is allowed to charge for a particular good/service by law: govt has determined that the equilibrium price is too high (price must be lower so people can afford the good/service)
- A form of market regulation used to ensure that firms do not abuse their market power by charging consumers excessively high prices (particularly for goods which are considered a necessity [ex. water, electricity, food, rent])
- Often only used temporarily in exceptional situations such as during times of war, famine or after natural catastrophes (ex. during the COVID-19 pandemic, some countries established price ceilings for hand sanitizer after observing extreme increases in the price for this product)
*New equilibrium quantity demanded and quantity supplied: shortage = excess demand (see diagram)
Price ceiling impacts
- Producers: Sell a lower quantity at a lower price and may need to reduce employment (less being produced)
- Consumers: Pay a lower price, but there’s less available to buy
- Govt: May be a popular move if price benefit outweighs shortage impacts
- Workers: Lower producer quantity and rev may lead to unemployment
- Society: Shortages—some people don’t get product, and this can result in underground or parallel markets (black market); non-price rationing (lines, coupons, or favoritism); under-allocation of resources to that good (allocative inefficiency); and welfare loss
Price floor
- Min price, set above the market price, that a seller must charge for a particular good or service by law: govt has determined that the equilibrium price is too low and must be higher so producers can make sufficient profit (often used w/ food and wage prices)
- A form of market regulation used to provide income support to producers
- Often only used temporarily in exceptional situations such as when there is a bumper crop (abnormally large harvest) of an agricultural good: they are also seen in the case of employee wages for lower skilled workers through the policy of a minimum wage
*See diagram
Price floor impacts
- Producers: Sell a higher quantity at a higher price
- Consumers: Pay a higher price for a lower quantity
- Govt: Likely that it becomes the buyer of the surplus
- Workers: Can benefit if higher demand and producer revenue leads to job creation
- Society: Excess supply needs to be absorbed (long term issues); production inefficiency (limited incentive to minimize costs); overallocation of resources to that good (allocative inefficiency); and welfare loss (MC > MB)
Minimum wage impacts
- Labor surplus = excess supply = unemployment
- Illegal workers at wages below the minimum wage
- Misallocation of labor resources (changes signals in market and prevents market from working as intended)
- Misallocation in product markets (firms dependent on unskilled labor see an increase in costs [leftward shift in S])
Solutions for excess supply
- Govt could purchase excess supply and store—this could be used in the future if there is a shortage to increase supply (it could be given to those on low incomes for free/at a reduced price as part of a redistributive policy)
- Govt could purchase excess supply and destroy it (huge cost and waste/inefficiency)
- Govt could purchase excess supply and sell at a lower price to other countries (dumping): could lead to retaliation and a country imposing trade barriers
- Govt could set a quota which would force prices up to the min price (but this defeats the objective of giving producers more rev [may also lead to informal markets, hard to enforce])
- Govt could increase demand through advertising/protectionist policies against foreign substitutes
Direct tax
Tax on income or profit (ex. income tax, corporation tax)
Indirect tax
Tax imposed on expenditure/ consumption (ex. a sales tax). Two types: specific and percentage/ad valorem (see diagram).
Tax purposes
- Increase in tax rev for govt
- Income redistribution
- Reduction in consumption of harmful goods
- Improved allocation of resources by reducing negative externalities
*differs as a % of total rev for countries…
Specific tax
A specific (fixed) amt of tax that is imposed upon a product (ex. N500 per unit): this will shift the supply curve up/to the left by the amount of the tax.
Percentage/Ad valorem tax
Tax is a percentage of the selling price: as the price increases the amount of tax increases and so the supply curve will shift up/to the left and be tilted away from the original supply curve.
Indirect tax impacts
- Producers: Sell a lower quantity at a lower price
- Consumers: Pay a higher price and able to buy less
- Govt: Receives revenue
- Workers: Potentially lose if reduced producer revenue leads to job losses
- Society: Under-allocation of resources to that good (allocative inefficiency); producer and consumer surplus reduced; welfare loss (part of both the producer and consumer surplus is transformed into government revenue [but MB > MC, so welfare loss is to to less being consumer than socially optimal])
How who pays the share of the indirect tax may differ
- PED and PES impact the sharing of the burden of an indirect tax between consumers and producers: the group with the more inelastic response pays a higher share of the tax
- When PED < PES, the tax incidence is mainly on consumers; when PES < PED, the tax incidence is mainly on producers
*see diagram…
Subsidy
- An amt of money paid by the govt to a firm per unit of output (ex. N500 per kg of steel)
- Can take other forms (ex. low-interest loans, consumer subsidies, provision of lower cost goods, tax relief), but our focus will be on the idea above
- Can be effective and positive when used in the short term (long-term subsidies are almost always negative and become ingrained in the economy [agricultural subsidies in the developed countries, fossil fuel production subsidies in the US and elsewhere])
*total govt spending is the difference between consumer and producer price times the new quantity: part of this goes to consumer surplus, part to producer surplus (the triangle a goes to neither and is the welfare loss)—see diagram
Why a govt might give a firm a subsidy
- To lower the price of an essential good (so more people can afford it and, subsequently, consumption increases)
- To guarantee the supply of products that the government thinks are necessary for the economy (the product itself [such as food or power] or b/c the industry employs a significant amount of people)
- To support selected producers (to enable producers to compete with overseas trade [thus protecting the home industry] or to enable exports)
- To encourage the consumption of merit goods
Subsidy impacts
- Producers: Sell a higher quantity at a higher revenue (consumer + subsidy), may increase employment
- Consumers: Pay a lower price and able to buy more (W)
- Govt: Significant spending to fund the subsidy
- Society: Production inefficiency (limited incentive to minimize costs); overallocation of resources to that good (MB < MC [allocative inefficiency]); producer and consumer surplus increased; welfare loss (increased consumer and producer surplus funded by government—welfare loss due to larger than optimum quantity produced)
Direct provision of service
Public transport, rail networks, telecommunications, airlines, education, energy…
Command and control regulation and legislation (smoking intervention ex.)
Increased taxes, but also advertising bans, packaging rules, age limits, smoking bans (locations)…
What consumer nudges work?
Easy: Simple to implement and grasp
Attractive: Get attention
Social: We are influenced by others around us
Timely: When are people responsive?
