Economics - Government intervention

Reasons for government intervention

Reasons for government intervention

correct market failure, earn government revenue,
promote equity, support firms, support poor households

common methods of intervention

indirect taxation, subsidies, max prices, min prices

indirect tax and types

only paid when consumers make a purchase, usually used on demerit goods (specific or ad valorem)

demerit good definition

goods with harmful impact on consumers/society

specific tax definition and outcome

Fixed tax per unit output (eg. 3.25/pack cigarette)

- Supply curve shifts from s1 to s2 by the amount of the tax

- Price consumer pays increases from p1 to p2
- price producer receives decreases from p1 to p3

- government recieves (p2-p3) x q2

- consumer and producer each pay a share of the burden

- new equilibrium at p2 q2

- final price higher and qd lower

ad valorem tax

tax is percentage of a purchase

- initial equilibrium at p1q1

- supply shifts left and curves diverge as more tax at higher prices

(same process as for specific tax)

advantages and disadvantages of indirect tax

advantages: raises price/reduces quantity of demerit goods, raises revenue for government programs

disadvantages: effectiveness of the tax depends PED, may create illegal markets, producers may be forced to lay off workers

burden in inelastic vs elastic PED

inelastic PED: curve is steeper, producers pass on higher proportion of tax to consumers and pay the rest

elastic PED: curve is less steep, producers pass on smaller proportion of tax to consumers

Producer subsidy

per unit amount of money given to a firm by the government to increase production, specifically of merit goods

Subsidy result

- Supply curve shifts to the right

- increases QD in the market and lowers price

- producers receive p2 plus subsidy per unit (so p3)

- prices decrease for consumers

evaluatation of subsidies

advantages: help specific industries, lowers prices and increases demand for merit goods, used to compete internationally

disadvantages: often results in excess supply, opportunity cost associated with government expenditure, reduces the need to be more competitive

Price ceiling

set below the free market price equilibrium to help consumers (real estate market, petrol), creates excess demand (shortage) because lower price reduces incentive to supply (contraction in qs) and increases incentive to buy (expansion in qd)

evaluation of price ceiling

Advantages: - some consumers benefit from lower prices aka increased consumer surplus

- stabilise markets in short term

Disadvantages: - some consumers unable to purchase due to shortage

- producer surplus falls

- illegal markets
- inefficient allocation of scarce resources

price floors

Set by the government above the existing free market equilibrium price, increases incentive to supply and decreases incentive to buy so there is a surplus

Evaluation of price floors

Advantages: In agricultural markets producers can keep business up (government usually buys excess supply)

Used in demerit market for output to fall (government do not purchase excess supply)

Disadvantages: Government forced to purchase excess supply (opportunity cost), farmers become over-dependent, unemployment

Evaluation of minimum wages

Advantages: Guarantee minimum income, increase consumption in economy due to higher income

Disadvantages: Raises cost of production for firms (could lead to increase in price of product)

Unemployment

Direct provision of services

Public goods which are beneficial for society are not provided by private firms. (Roads, parks, lighthouses) They are usually provided free at consumption so anyone can use them. Paid for by general taxes, opportunity cost, excess demand (waiting time at hospital)

Legislation

creating laws

Regulation

monitoring and enforcing laws