Unit 4 Government Intervention Flashcards
reasons for govt intervention
to raise revenue, support firms, support low income households/promote equity, influence the level of production & consumption of certain goods and services/correct market failures
how the govt intervention raises their revenue
taxation
tax revenues
a government’s primary source of revenue
direct taxes
taxes on incomes earned by households and firms
indirect taxes
taxes on consumption which are paid by consumers through producers, and are given to the government
“Progressive in nature”
the percentage paid is proportional to the income received
“Regressive in nature”
low income individuals pay more as a percentage of their income
methods for govt intervention to supports firms
subsidies to certain firms/industries, tax concessions to certain firms/industries, protectionist measures from imports for certain firms/industries, loans to certain firms/industries, financial bailouts to certain firms/industries
rationale for govt intervention to supports firms
to help small industries grow, to protect jobs from overseas competition, to protect infant industries, to ensure critical/strategic industries are operational
methods for govt intervention to support low income households/to promote equity
taxes, transfer payments, providing basic infrastructure - water pipes/electricity etc.
rationale for govt intervention to support low income households/to promote equity
the free market economy is designed so that those who work hard, have skills, have opportunities, have risk-taking outlook, or have ownership of factors of production will be rewarded, is not concerned with equity, and will make people low income - lacking the money for the basics of living (sanitation, education, health, malnutrition etc.)
negative externalities
goods that create negative spillover costs, both when consumed and/or produced e.g. pollution
methods for govt intervention to influence the level of production & consumption of certain goods & services/to correct market failures
combination of regulation/legislation, the government tries to influence (decrease) the levels of consumption/production
rationale for govt intervention to influence the level of production & consumption of certain goods & services/to correct market failures
the free market overproduces products
market failures the govt corrects
positive and negative externalities created by consumption and production, monopoly/power abuse, public goods, demerit and merit goods
two types of taxes
direct, indirect
types of direct taxes
income, corporate, capital gains
income taxes
money taken out of wages
corporate taxes
money taken out of any profit made
capital gains taxes
money taken out of profit from investments, bank interest, shares, property
types of indirect taxes
specific (unit/excise), ad valorem
specific taxes
a fixed amount of tax per unit on a particular good or service sold
ad valorem taxes
a fixed percentage of the price of the good or service, general sales taxes or value added taxes - the amount of tax increases as the price increases
why the govt imposes indirect taxes
source of revenue, method to discourage consumption of harmful goods, can be used to redistribute income, method to improve the allocation of resources by correcting negative externalities
how excise taxes can be used to redistribute income
luxury goods are taxed to narrow the difference between higher and lower income earners
stakeholders
individuals or groups have an interest in something and are affected by it
consequences of indirect taxes for consumers
receive less of the good and are paying more for it
consequences of indirect taxes for producers
experience a fall in their revenues
consequences of indirect taxes for workers
fewer workers are needed to produce products → unemployment
consequences of indirect taxes for the govt
the only stakeholder that gains, as it gains tax revenue for its budget
other consequences of indirect taxes
taxes raise prices → shift supply curve to the left and reduces output → market size shrinks, unemployment
subsidy
assistance by the government to firms, consumers, industries or sectors of an economy; acts as an incentive to produce more and lowers the marginal cost of production
subsidy forms
direct cash payments or other forms of assistance e.g. low-interest for college tuition or buying a home, tax relief
rationale for subsidies
- to increase the consumption of goods by lowering the price
- support a particular industry by helping with production costs
- encourage exports and address a balance of payments deficit by increasing export revenue
- encourage other firms to join the market and hence increase competition/prevent monopolies arising
merit goods
goods deemed beneficial for society
graphical impact of subsidies
shifts the supply curve to the right by the amount of the subsidy because producers are willing to supply more than previously, as the govt is subsidizing the cost - reduces the market price, increases quantity traded
impact of subsidies on consumers
consumers benefit, as the market price is lowered, thus more people are able and willing to buy the good
impact of subsidies on producers
producers benefit, as their production costs are reduced which helps to improve their competitiveness and profitability
impact of subsidies on the govt
govts spend money on financing the subsidy, but there is an opportunity cost in doing so the net benefits to society may outweigh the costs
advantages of subsidies
- controls price inflation
- boosts employment (especially in poor areas)
- improves human capital/productivity
- protects infant industries
- promotes growing demand for renewability
- improves affordability for low-income individuals
disadvantages of subsidies
- distortion of market prices
- risk of fraud for subsidy payments
- expensive, high cost for taxpayers
- inequitable, many rich people benefit
- environmental damage (subsidies on energy industries reduce the incentive to make efficient use of energy)
- protects inefficient businesses
impacts of subsidies on market outcomes
- equilibrium of quantity produced and consumed increases (Q* → Qsub)
- equilibrium price decreases (P* → Pc)
- price received by producers increases (P* → Pp)
- government spending increases (0 → (Pp - Pc) x Qsub)
- over allocation of resources, as Qsub is more than Q*
- firm’s supply curve shifts to the right
consequences of subsidies for consumers
better off - decrease in price of goods (P* → Pc), increase in quantity purchased (Q* → Qsb)
consequences of subsidies for producers
better off - prices increases (P* → Pp), quantity produced increases (Q* → Qsb), higher revenue from (P* x Q*) → (Pp x Qsb)
consequences of subsidies for the govt
worse off - to obtain revenue for the subsidy, the government has to reduce expenditures elsewhere in the economy and may have to raise taxes or run a budget deficit
consequences of subsidies for workers
better off - output expands from Q* → Qsb, firms are more likely to hire more workers to produce the extra output
positive consequences of subsidies for society
society consumes more merit goods, society gets more equitable, as poor people can afford basics of life
negative consequences of subsidies for society
over allocation of resources (Q* → Qsb), the higher price received by producers (P* → Pp) allows relatively inefficient ones to continue producing, subsidy has to be paid for with taxes
negative consequences of subsidies for foreign producers
worse off - subsidies are positive for domestic producers, but negative for the producers of other countries who are unable to compete with the lower price of the subsidized goods
price controls
a form of government intervention where maximum prices (price ceilings) and minimum prices (price floors) are imposed so that prices are unable to adjust to their equilibrium level determined by demand and supply
result of price controls
market disequilibrium, and therefore shortages (excess demand) or surpluses (excess supply)
how price controls differ from taxes and subsidies
once they are imposed, they do not allow a new equilibrium to be established and thus forces a persistent market disequilibrium
price ceiling
the maximum legal price the government sets for a particular good, below the equilibrium price
result of price ceilings
a lower quantity supplied and sold than at the equilibrium price, results in a shortage (excess demand)
examples of price ceilings
basic commodities in the Philippines, domestic air travel during World Cups
impacts of a price ceiling on supply
- suppliers would be less willing to supply at the PMax$, leading to a shortage
- shortages can lead to parallel markets e.g. black markets or more expenses elsewhere e.g. rationing systems, policing/enforcing and other inspectors
consequences of a price ceiling on the economy
shortages, non-price rationing, underground (parallel) markets, rnderallocation of resources to the good and allocative inefficiency
non-price rationing
refers to a method of dividing up something among possible users
positive impacts of a price ceiling on consumers
gain from producers, those who are able to buy the good at a lower price are better off
