Government Intervention

market

a place where buyers and sellers of a product come together to make an exchange or trade.

market equilibrium

forces of supply and demand are in balance, and there is no tendency for the price to change. QS=QD

equilibrium

the state of balance between different forces, such that there is no tendency to change.

opportunity cost

The next best alternative forgone when an economic decision is made.

elasticity

measures how much quantity responds to a change in price.

Price elasticity of demand(PED)

a measure of the responsiveness of the quantity of a good demanded to changes in its price.

Calculation: %change in QD / %change in price

3 Determinants of PED

1. number of closeness in substitutes - more substitutes, the more elastic demand. if price of good with many substitutes goes up, consumers will switch to another substitute product

2. degree of necessity - goods that we think are essential to our lives are more essential than luxury products

3. proportion of income spent - larger proportion of one's income is needed to buy a good, the more elastic the demand

significance of PED for government in relation to indirect taxes

The government often imposes taxes on specific goods. if the government wants to increase their taxes they must first consider the goods PED. This is because the tax may effect consumers and producers differently.

indirect taxes

Imposed on spending to buy goods and services

Why do governments impose indirect taxes?

1) source of revenue

2) method of discouraging consumption of goods that harm the individual

subsidies

assistance by the government to individuals or firms

Why does the government provide subsidies?

1) can be used to increase revenue and income of producers

2) used to encourage production and consumption of particular goods and services that are believed to be desirable for consumers

3) can be used to make certain goods affordable to low-income consumers

4) can be used to support the growth of particular industries in an economy

5) used to encourage exports of a particular good

price controls

the setting of a minimum or maximum price by the government so that prices are

unable to adjust to equilibrium level determined by demand and supply. results in market disequilibrium, and therefore shortages and surpluses

price ceiling

a maximum price for a particular good, and means that the price legally charged by sellers of the good must not be higher than the legal maximum price. It is set below the equilibrium price and leads to shortages, and thus excess demand. An example of price ceiling: certain food prices and rent prices.

Consequences of price ceilings

1) shortages: not all interested buyers are able to buy something because there is not enough of the good being supplied

2) insufficient resource allocations: lower equilibrium price results in a smaller quantity supplied than the amount determined at equilibrium. there are not enough resources allocated for production causing underproduction

3) underground market: selling products illegally

4) non-price rationing: rationing occurs among consumers

price floor

legally set minimum price. price charged by sellers can't be lower than the price floor. Set above equilibrium price and results in excess supply

Why does the government set price floors?

1) provide support for farmers by offering them prices for their products that are above the equilibrium

2) protect low-skilled, low-wage workers by offering them a wage that is above the level determined in the market

Consequences of a price floor

1) surpluses created

2) government actions to get rid of surplus, export, store(creates additional costs), or send it to developing countries(local farmers can't compete)

3) creates inefficiency because firms can't cut costs

4) creates over-allocation of resources to the production of the good and allocative efficency