IB SL Microeconomics Government Intervention

reasons for government intervention in markets

• earn government revenue

• support firms

• support households on low incomes

• influence level of production

• influence level of consumption

• correct market failure

• promote equity

price ceiling

maximum legal price of a product imposed by law. price above which products are not allowed to charge and its always below the market price

reason for price ceiling

equity: impose on necessity

accessibility: impose price on merit good and make it more accessible to low income group

benefit of price ceiling

• lower the expenditure of low income group on necessities → retain more money for investment and saving to break the poverty cycle

• protection against volatile prices that harms the low income group

• prevent low income group from not having enough necessity

• lower the high living costs in city → attract rural urban migration

concern of price ceiling

• only temporary relief

• shortages

• people need to queue up for a long time

• discourage producer from improving the quality

• encourage under supply → further increase the price

• back market

• government may need to intervene by rationing → opportunity cost

price floors

minimum legal price of a product et by the government → price below which producers are not allowed to charge → higher than the market price

reason for price floor

• price floor on salary (minimum wage) improve income distribution equity

• support the income of domestic producer

• decrease the consumption of demerit goods

benefits of price floor

• guarantee a minimum income of producer

• protection against volatile prices

• prevent producers who would not be covering costs from going out of business

• support rural employment and may prevent rural urban migration

concern of price floor

• temporary relief

• over supply → further lower the price

• opportunity cost of gov → sell the surplus

• discourage producers from diversifying

indirect taxes

tax on transaction and production

reason for indirect taxes

• collect tax revenue

• impose indirect taxes on industries having negative externalities

• decrease the consumption of demerit goods

flat rate vs ad valorem

• per unit tax → fixed amount

• percentage tax → proportional to the price of producer

benefit of indirect tax

• gov can collect tax revenue and achieving income redistribution

• decrease the production and output level of negative externalities

• producing substitutes without negative externalities and achieve allocative efficiency

concern

• tax is a leakage to the circular flow of income → economic growth drops

• exerts inflationary pressure

• lower the incentive of the producer to produce

• decrease employment

• producing complement will be worse off

subsidies

financial aid or support provided by the gov to an economic sector aiming to promote the economic activity and reduce production costs

reasons for subsidies

• on infant and strategy industries and protect them from foreign competition

• impose on industries having positive externalities

• impose subsidies to increase the consumption of merit goods

benefit of subsidies

• reduces cost and increase profitability → incentives firms to produce more

• lower the production costs (subsidy on raw material) → decreasing price of the product produced

• more competitive → increasing exports and reducing imports

• increase employment

concern of subsidies

• opportunity cost involved

• overall welfare loss and allocative inefficiency

• distorts the pattern of trade

• domestic firms may seen as protection → rise to retaliation form trading partners

direct provision of welfare services

• gov invest in social health insurance organization→ direct provision of healthcare

• education → gov run or subsidised

• legislation

market failure

too much or too little products or services are produced and consumed → socially undesirable and allocative efficiency, socially optimum level of output is not achieved

welfare loss

external costs on the third party that is not involved in the market

advertising

market communication of sending out non-personal message to sell a product

carbon tax

indirect tax on the economic activites involving the emission of carbon dioxide → aim to reduce the negative externalities produced by these economic activites

regulation

rules imposed by the government aiming to modify the economic behaviour of people and firms

merit goods

benefit to the society which is not taken into account by the consumer → positive consumption externalities to the society

demerit goods

cost to the society which is not taken into account by the consumers → negative consumption externalities to the society

sustainability

development that meets the needs of the present generation without compromising the ability of future generations to meet their needs

rivalrous resources

resource which cannot be consumed by two or more people at the same time

non-rivalrous resources

can be consumed by any number of people at the same time

excludable resources

a resource which can excluded people from consuming it

non-excludable resources

impossible to exclude people from consuming it

common pool resources

• rivalrous

• non-excludable

• eg: air and water

tragedy of commons

individual producers acts independently according to their individual utilities to use common pool resources → deplete or spoil the common pool resources

arguacultural products

primary products produced from the sea

gov policy on common pool resources

• legislation and regulation

• collective self-governance

• international agreement

• tradable permits

• carbon tax

public goods

• non-rivalrous and non excludable

free rider problem

• cost does not increase if more people consume it → consumption of public goods is benficital → will use public gods without paying it → firms do not like to produce public goods

direct provision by government

• free for consumers but not for government

• government need to use its expenditure to provide the public good

• arise political conflict or moral hazard

contracting out the private sector

decrease the size of the bureaucracy of the government

issue contact to private firms to provide the public goods and services

paid by government but the services is run by private firms