econs mixed economy system

Mixed economic system

• An economic system that combines the use of free market economic system with some government planning and control to determine the allocation of resources in the economy

• Ownership of resources and decision making is split between private and public sector

Types of government intervention

1. Direct government provision

2. Regulations (which includes price control )

3. Indirect tax

4. Subsidies

Nationslization

• where government takes over ownership of private sector companies or industries

Direct government provision

• refers to government producing and supplying goods and services directly to people

• Affects consumers not producers (subsidies)

• Using money collected from taxes (take from consumer) or borrowing ( need to pay back money to borrower)

• Supplied “free of charge” to people or charge a price at a subsidised rate (merit good) —> lack of public good

Direct provision is used to correct which market failures

• lack of public good (eg. Government directly provides streetlamp , national defence )

• Under production of merit goods and goods with high external benefits (goal : increase supply of merit good)

• Abuse of monopoly power (government may nationalise industries that provide essential services such as public utilities like water , aircon ,electric to prevent private sector monopolies from restricting supply and raise prices)

Advantages of direct provision

1. Directly increase supply of public goods and merit goods that are either underproduced or not produced in a free market

2. nationlization may directly prevent private firms from abusing their monopoly power

3. More people (low income consumers) can consume the good at lower prices or free of charge

4. Ensure that essential services will still be provided even if it is making a loss

5. Can protect or increase employment by providing jobs for people

Disadvantages of government provision

1. Opportunity cost may be high (choosing to spend more on one good may mean less spending on other important areas)

2. Government may increase taxes in order to provide the good “free of charge” or at a subsidised price —> greater tax burden for people

3. If government borrows money to fund the production —> debt burden will increase

4. Government may be inefficient and produce poorer quality goods —> gov is non profit motivated - > little incentive to be efficient and cut cost and quality of goods and services may be poor

Regulations (including price control)

• regulations are legal rules made by a government to control the behaviour of the people and firms , or control the way something is done

• If people and firms fail to comply —> they may have to pay fines or be imprisoned

• Aim:to produce a more socially desirable outcome by controlling the forces of demand and supply in a regulated market

examples of regulations

1. The ban on consumption or production of certain products

2. Making the use of certain foods compulsory

3. Setting certain minimum standards for goods and services that producers/consumers must follow.

Government regulations may include setting price controls such as

1. Maximum prices (price ceiling )

2. Minimum prices (price floor)

Regulations are used to correct the following market failures

1. Over consumption of demerit goods and activities with high external cost (price floor)

2. Under production of merit goods and goods with high external benefits (price ceiling)

3. Abuse of monopoly power

Over consumption of demerit goods and activities with high external cost , how does regulation correct this market failure

eg. 1 : ban smoking at certain places / ban sake of alcohol after certain hours , to decrease consumption / production of demerit goods

Eg. 2: ban littering / single use plastics / restricting amount of pollutants firms can release into environment / environmental regulations , to decrease negative externalities (harmful spillover effects)

Eg 3 : setting price floor (higher price ) on sale of alcoholic drinks , to reduce consumption of demerit goods

Underproduction of merit goods and goods with high external benefit , how does regulations correct this market failure

• compulsory basic education / vaccination —> to increase consumption of merit goods (lower prices )

Abuse of monopoly power , how does regulations affect this market failure

• to prevent firms from exploiting consumers ( restricting supply + raising prices ) government can

1. Set a minimum acceptable service standard (eg, product safety , product quality , delivery time)

2. Set a maximum price (price ceiling) that the firm can charge

Advantages of regulations

1. Total ban / restrictions are quite effective in correcting the market failure directly

2. Simpler to implement (compared to indirect tax / subsidies )

Disadvantages of regulations

1. High monitoring cost —> government needs to allocate extra resources to monitor behaviour and enforce the law —> OPP cost —> resources could be used in other areas

2. Regulations that restrict / ban production may force many companies to shut down —> unemployment may increase

3. Complying with health and safety regulations , environmental regulations and other regulations will cause higher cop, lesser supply , more expensive (higher prices)

4. Reduces freedom of choice

5. Penalty is too low = people and firms may not comply with regulations

6. Compulsory education / vaccinations may not be effective if the poor cannot afford to pay for the good

Price control (under regulations ), price ceiling definition

A legal maximum price on a good ser by the government that is below the market equilibrium price

(Price too high, set lower)

Why does the government set a price ceiling

• to make certain essential goods affordable to the poor

• To prevent monopoly firms from overcharging consumers

*never on luxury goods

Eg, food price control (essential food, rice , bread) / rent control

Why do governments need to put a price ceiling

1. Original market equilibrium price is too high

2. So government sets maximum price / price ceiling and it is illegal to charge a price above price ceiling

3. At price ceiling = quantity supplied decreases , but quantity demanded increases

4. Now, quantity demanded is more than quantity supplied

5. There is excess demand , causing a shortage

What is a price floor

A legal minimum price on a good set by the government that is above the market equilibrium price (raise price)

Why does government set price floor

1. Support producers / workers by increasing their income they received

2. Reduce consumption of demerit goods / goods with high external cost by increasing the price paid

Examples of price floor

Eg 1 : agriculture price support : to support farmers income

Eg 2: minimum wage : to support wages of low skilled workers

Eg 3 : minimum price for alcoholic drinks : to reduce consumption of alcohol

Why do governments set price ceiling

1. original market equilibrium price is too low

2. So government sets minimum price / price floor , illegal to charge a price below price floor

3. At price floor , quantity supplied increases but quantity demanded decreases

4. Hence, quantity supplied is more than quantity demanded

5. Causing a surplus, excess supply

Advantages of price floor

Disadvantages of price floor

Indirect taxes

• Taxes imposed on goods and services

• Used to correct the market failure caused by overconsumption of demerit goods and activities with high external cost

• Eg cigs/alcohol

Why does indirect tax lower quantity demanded

• when price is too low, there is over consumption and production of the good

• Government imposes indirect tax to increase cop and reduce profitability for firms , decreasing supply for S-S1

• Between S-S1 —> vertical distance between the 2 supply curves is the tax per unit

• Market price increases from P -P1

• quantity demanded decrease from Q -Q1

Advantages of taxes

1. Can help internalise the externality —> making consumers / producers pay for the harm / damage that they are causing to others

2. Government collects tax revenue —> can be used to finance government spending eg. To pay for campaigns to educate people about harmful effect of demerit goods or the external costs brought about by their activities

Disadvantages of tax

1. Demand may be price inelastic for some goods (PED<1) , Eg.cigs —> increasing tax may be ineffective as a percentage fall in quantity demanded is less than the percentage rise in price

2. The poor may end up worse off —> so, eg goods that are taxed are necessaries —> by paying more for these necessities , they have less money to spend on other necessities

3. domestic firms may suffer losses and some workers may become unemployed —> as firms cut production due to higher cost

Subsidies

A payment made by the government to producers to help reduce cost of production

• can be used to correct market failure caused by underconsumption of merit goods and activities with high external benefits

How does subsides solve market failure

1. Original price is too high so there is an underconsumption and underproduction of goods

2. Government provides subsidies to the firm to reduce cost of production, increase profitability and causes supply to increase from S-S1

3. Vertical distance between 2 supply curves = subsidies per unit

4. Market price falls from P-P1

5. Quantity demanded increases Q-Q1

Advantages of subsidies

1. Makes the goods more affordable —> more poor people can now afford to consume the good

Disadvantages of subsidies

1. Opportunity cost may be high —> giving more subsidy on one good may mean less spending on other important areas

2. Government may have to increase taxes to pay for subsidies —> raise tax burdens for consumers / taxpayers —> they have less income to satisfy other wants —> opportunity cost for taxpayers

3. Government may over subsidies —> good becomes too cheap —> overconsumption —> wastage of resources

Advantages of government in a mixed economy

• can help overcome many problems of a market economic system and correct the various types of market failure

Disadvantages of government in a mixed economy

• Government intervention takes a long time to agree and have an impact

• Price controls may encourage smuggling and black markets

• Taxes and subsidies and price controls can distort price signals ( price can’t change) and incentives

• Regulations can increase cost and price

• Public sector organisations may be inefficient or poor quality

• Cause conflict of interest

• Some government intervention may be based on political or personal choices

(All these lead to inefficient allocation of resources )

due to problems created by government intervention ,

Many countries are trying to reduce the size of the public sector and increase the role of market economic system

How to reduce government intervention and increase the role of markets in the mixed economic system

1. Privatisation

2. Cutting taxes and public spending

3. Deregulation

Privatisation def

Where government sell or transfer state owned enterprises and public sector activities to private sector firms

De regulation

Removing regulations ( including price control)

Advantages of increasing the role of markets in mixed economic system

1. Reduces problems created by government intervention = increase efficiency = cut cost =lower prices and improve quality of products produced

2. Increase in economic welfare when resources are efficiently allocated

Government intervention is only needed in

Certain essential areas

Not in essential areaS

Greater role of free market in resource allocation decisions