micro 2.7- government intervention

Question 1

give 7 reasons for government intervention in markets

Answer 1

• earn govt revenue
• support firms
• support households on low incomes
• influence levels of production
• influence levels of consumption
• correct market failure
• promote equity

Question 2

state 4 main forms of government intervention in markets

Answer 2

• price controls: price ceilings (max prices) and price floors (min prices)
• indirect taxes and subsidies
  (- direct provision of services
• command and control regulation/legislation)

Question 3

define a specific tax

Answer 3

a tax imposed on an absolute value per unit of good sold (eg fuel tax, tobacco duty, alcohol duty, sugar tax, like £1 per unit)

Question 4

define an ad valorem tax

Answer 4

a tax imposed on a fixed percentage of the price of the good (eg VAT)

Question 5

describe how an ad valorem tax changes a supply/demand diagram

Answer 5

ad valorem tax will cause an increase in the cost of production so the supply curve will decrease and shift to the left

steeper gradient than original supply curve

Question 6

describe how a specific tax changes a supply/demand diagram

Answer 6

specific tax will cause an increase in the cost of production so the supply curve will decrease and shift to the left

same gradient as original supply curve

Question 7

distinguish between an indirect tax and a direct tax

Answer 7

direct - a tax paid directly to tax authorities (ie tax on income)
indirect- taxes on expenditure (consumer->producer->govt)

Question 8

why does consumer and producer burden depend on the PED of a product?

Answer 8

if the product is elastic, producer burden will be higher- producers will keep tax burden themselves as they do not want to lose customers due to raised prices

Question 9

evaluate the effect of taxes on stakeholders in the market

Answer 9

consumers:
- More expensive products and then enjoy less (Q2)
- CS decreases
- Consumer expenditures depend on PED. If PED is inelastic then expenditures increase and if PED is elastic then expenditures fall
- Lower income groups suffer more as VAT is a greater proportion of their income (regressive tax)
- If the tax is placed upon a harmful good then consumers might benefit if they consume less

producers
- TR drops
- producer surplus decreases
- international competitiveness may fall because they now seem more expensive, causing exports to decrease

governments:
- Their tax revenues increase
- If the tax revenues are used efficiently then the whole society will benefit

society:
- Under allocation of resources since quantity will decrease so unemployment in the specific sector might increase
- deadweight loss since resources as misallocated, unless the tax is used to lower production of harmful goods

Question 10

why do govt prefer to tax goods with inelastic PED?

Answer 10

Their tax revenues are higher
Less damage to producers
Less increase in unemployment
The tax burden will be spread amongst many consumers instead of few producers

Question 11

give 4 reasons why govt give subsidies?

Answer 11

• To make necessities more affordable for lower income households
• To provide more merit goods (benefit society), eg vaccines/education
• To make domestic producers more competitive and thus to be able to compete with foreign producers and increase exports
• To protect the environment by subsidising green technologies

Question 12

define subsidies

Answer 12

payments made by the government to producers to increase production

Question 13

state the effect of subsidies on a supply/demand diagram

Answer 13

decrease cost of production so supply curve increases and shifts to the right

Question 14

when PED is inelastic, benefit to producers due to subsidies is ? than consumers. why?

Answer 14

smaller; consumers were going to buy it anyways but now they can spend less

Question 15

evaluate the effect of subsidies on stakeholders in the market

Answer 15

consumers:
- Cheaper products and they can enjoy more
- consumer surplus increases
- consumer expenditures depend on PED

producers:
- TR increases
- producer surplus increases
- international competitiveness may increase (when prices are lower, exports may increase)
- greater risk of producers becoming inefficient
- foreign producers will seem less competitive (small scale farmers from LDCs won’t be able to compete with large scale subsidised farmers ->inequity)

Question 16

define maximum prices

Answer 16

prices set by the government below the equilibrium price, which prevents producers from raising the price above it.

Question 17

give 2 examples of countries with maximum prices

Answer 17

Example 1 - Venezuela (milk, toilet paper, medicine and rice)
Example 2 - Manhattan ( rent controls)

Question 18

give 3 reasons why maximum prices exist

Answer 18

To protect low income consumers from high free market prices
To restrict monopolies from raising prices and exploiting consumers
To resist very high salaries (caps on pay and bonuses, CEOs and NBA)

Question 19

evaluate the imposition of maximum prices

Answer 19

• There is a shortage as Qd>Qs
• There is underallocation of resources

Consumers:
- sometimes they are better off as they enjoy the product at a lower price
- some are worse off as they don’t get to enjoy the product due to the shortage
- it is important to protect low income families from high food prices as food is the largest proportion of their income and so if prices increase they may not be able to buy necessities

Governments: lower tax revenues due to less VAT
Producers: their total revenue falls

Price mechanism is distorted and the rationing method fails as a result.

The impact on the different stakeholders depends on how low the Pmax was set (and the PES and PED, more elastic means more impact)

Question 20

give 2 negatives of price maximums

Answer 20

limited quantity may be rationed unfairly:
- connections/favouritism (discrimination e.g people with small children may not get a house)
- Black markets ( the more inelastic the PED the more likely it is to have black markets)

Question 21

how does the govt resolve problems created by the shortage?

Answer 21

Increase supply by providing subsidies
Increase supply by providing products themselves
Direct provision from imports from abroad given out by the government

Question 22

define rent controls

Answer 22

the maximum legal rents in order to make housing more affordable for low income group

Question 23

how do maximum prices affect supply/demand graph?

Answer 23

line BELOW equilibrium

Question 24

evaluate the imposition of rent controls

Answer 24

landlords:
- earn less.
- the ones that give their houses through black markets earn more
- When landlords switch to Airbnb in order to avoid rent controls, the supply of rented accommodation decreases (there is a max amount of days you can rent it)

tenants:
- some find cheaper accommodation
- some might find a lower quality house as landlords don’t have the incentive to maintain them
- some tenants are worse off as they don’t find any accommodation due to the shortage (Qd>Qs)

Question 25

give a real life example of rent controls

Answer 25

Rent control has been in force in many of Germany’s largest cities, including Hamburg, Berlin, Stuttgart and Munich, for many years. This stipulates that “cold” rents (excluding utilities) cannot be more than 10 percent higher than the local comparative rent.

Question 26

define a minimum price

Answer 26

prices set by the government above the equilibrium price, that prevents producers from reducing the prices below it.

Question 27

give 2 reasons for setting minimum prices

Answer 27

• To protect small scale producers (mainly farmers) from low market prices. They need to earn revenues that will allow them to enjoy good living standards
• To decrease the consumption of demerit goods (e.g. cigarettes, alcohol)

Question 28

describe the effect of a minimum price on a supply/demand diagram

Answer 28

new line above the minimum
(-) Surplus: Qd<Qs

Question 29

evaluate the effect of a minimum price

Answer 29

Consumers:
- need to pay a higher price and they enjoy less

producers:
- If the government intervenes (for agricultural products) and buys the surplus, causing their TR increase
- If the government doesn’t buy the surplus then some are better off as they sell at higher prices and some aren’t as they don’t sell due to the surplus.

government:
- Cost of buying the surplus -> opportunity cost
- Cost of transporting and storing the product (some products can’t be stored as they are perishable)
- What to do with the product?
- Inefficiency might occur: firms might overproduce if they know that the government will buy their excess supply

Over allocation of resources
The impact on the different stakeholders depends on how high the Pmin was set (and the PED and PES)

Question 30

what can the govt do in response to the surplus after minimum prices are set?

Answer 30

• buy the product so demand increases
• advertise the product so demand increases
• increase tariffs so demand for domestic product increases
• set a quota so producers limit their production to Qd

Question 31

what is the common agricultural policy?

Answer 31

EU policy to protect farmers
- Setting minimum prices for many agricultural products
- Setting import tariffs to protect from cheap imports
- EU purchases of surplus food to maintain minimum prices

Question 32

define a minimum wage

Answer 32

Minimum wages are wages above the equilibrium wage in order to protect employees from earning very low wages

Question 33

give 1 positive of the minimum wage

Answer 33

Some workers are better-off as they earn higher wages

Question 34

give 4 negatives of the minimum wage

Answer 34

• Some workers are worse off as they can’t find a job now (some were fired due to the wage increase, so their living standards drop)
• Producers are worse off as their costs of production increase -> lower profits (impacts depend: capital intensive vs human intensive and the extent to which they can pass on the higher cost of production to the consumer)
• Domestic producers may relocate to take advantage of lower wages -> loss of domestic jobs
• Government will be worse off as they need to retrain some unemployed people, pay unemployment benefits and potentially lose votes
• Black markets might be created if workers illegally accept to work for lower wages. More evident when a country has poor immigrants or high rates of unemployment -> Loss government revenues

Question 35

give 3 general evaluation points for the effects of minimum wage

Answer 35

• this affects low income workers
• the size of unemployment depends on the PED and PES for labour
• the size of unemployment depends and on how high the minimum wage is set