Topic 4: Government Intervention

Question 1

Describe price ceiling

Answer 1

def.: the government legally decrees that the price of a particular good cannot rise above a specified level

• Qs fall as suppliers are less willing to supply at this lower price
• Qd increase which leads to a shortage (Qd>Qs)
• Qs=what is bought and sold
• society is worse off as there is now a DWL which comes about because there is the opportunity for mutually beneficial gains from trade (at P1, MB>MC) but the low price is preventing this from taking place

Question 2

Describe price floor

Answer 2

def.: the government legally decrees that the price of a good cannot fall below a specified level

government imposes minimum price

• surplus does not always result as suppliers produce as much as they think they can sell at a price
• government sometime buys surplus produce

Question 3

Describe the effect of price controls

Answer 3

• price controls might be put in place for the best intentions - to protect consumers (price ceilings) or producers (price floors)
• however the result in both situations is a deadweight loss on society, because it creates a ‘wedge’ between the Marginal Benefit and the Marginal Cost as resources are not allocated to their most efficient use. Producers and consumers would like to undertake more trade, but are unable to.

Question 4

Describe taxes

Answer 4

• ‘necessary evil’ – in order for the government to pay for various welfare programs (health, education, infrastructure, pensions etc.), it must raise the revenue to do so
• consequence: distorts the price signal by changing prices
• keep S curve in graph as reflects resources actually being used still (marginal cost)
• effect: consumers now pay $12/kilo of oranges, and producers only receive $9/kilo
• $3 per kg goes to the government as tax revenue, $3 x 16,000 = $48,000
• DWL formes, gap between MB and MC formed due to trades that could be taking place but aren’t, the larger the tax, the greater the DWL
• government has a trade off: higher tax which leads to higher revenue but also higher DWL
• although the tax was $3 per unit, the consumer only paid $2 of that tax (and the producer paid the other $1)

Question 5

Describe the incidence/burden of tax

Answer 5

• depends on the elasticity of demand and supply of the good
• the burden of the tax fall proportionately more on the side of the market that is relatively more elastic

Question 6

Describe a subsidy

Answer 6

• def.*: a payment from the government to consumers or producers for each unit bought/sold i.e. university education, can be thought of as a negative tax
• still creates a DWL because the true MC>MB at the new equilibrium, appear that there is over production

Question 7

Describe subsidies

Answer 7

• def.*: a payment from the government to consumers or producers for each unit bought/sold i.e. university education, can be thought of as a negative tax
• still creates a DWL because the true MC>MB at the new equilibrium, appear that there is over production