IBDP Microeconomics Govt Intervention

Reasons for government intervention

Earn revenue for the government

Provide support to firms

Provide support to low income households

Influence the levels of production of firms

Influence levels of consumption of households/consumers

Correct market failure

Promote equity

Methods of government intervention

Subsidies, taxes, price ceilings, price floors, direct provision, command and control regulation

Command and control regulation

Laws that specify allowable quantities of pollution and which also may detail which pollution control technologies must be used (forces firms to take social costs of pollution into account)

Price controls

Price controls refer to the setting of minimum or maximum prices by the government (or private organisations) so that prices are unable to adjust to their equilibrium level determined by demand and supply, resulting in shortages or surpluses.

Price ceiling

A legal maximum price set by the government for a particular good (usually in order to make goods more affordable to people on low incomes)

Consequences of price ceilings

Shortages, Non-price rationing, Underground/illegal markets, Underallocation (allocatively inefficient), Negative welfare impacts

Welfare loss

Benefits that are lost to society because resources are not allocated efficiently.

Price ceiling consumer impact

Both gain and lose:
gain - consumers who are able to buy the good because of the lower price are better off

loss - some consumers cannot get the buy at all becuase of shortage

Price ceiling effect on governmnet

No effect, but may gain political popularity for making the good for affordable for low-income households

Price floor

A legal minimum price set by the government for a particular good (usually in order to provide income support to farmers or to increase the wages of low-skilled workers, discourage consumption of demerit goods)

Consequences of price floors

Surplus, government measures to dispose of the surplus (store - incurs costs for storage, export - involves subsidies to make competitive), firm inefficiency, (potential) overallocation of resources, negative welfare impacts

Price floor effect on government

Generally not effect BUT decreased funds for subsidizing exports or purchasing and storing surplus

Price floors effect on stakeholders in other countries

Producers in other countries may suffer from dumping as surpluses are sold abroad at a lower price.

If government does not provide support local producers are forced to sell their goods aborad at low prices, signalling that they should cut on production (law of supply), leading to underallocation of resources.

Indirect taxes

Taxes levied on spending to buy goods and services, called indirect because, whereas payment of some or all of the tax by the consumer is involved, they are paid to the government authorities by the suppliers (firms), that is, indirectly.

Direct taxes

Taxes paid on the income of firms and workers.

Reasons for indirect taxes

Source of government revenue, discourage consumption of demerit goods, redistribute income, Improve allocative efficiency by correcting negative externalities

Specific tax

A fixed amount of tax per unit of good or service sold

Ad valorem tax

A fixed percentage of price of goods and services (amount of tax increases as price increases)

Subsidies

Grants given by the government to producers to encourage the production of the good or service

Reasons for subsidies

Support producer revenues, make necessities affordable to low-income households, encourage consumption and production of merit goods, protect domestic firms/ make firms more competitive in the foreign market,

Subsidy effect on government

Negatively affected, as it may have to reduce expenditure elsewhere, raise taxes, or run budget deficit

State provision

When the government supplies goods and services such as education, health, and housing.

Negative production externality graph

Negative consumption externality graph

Positive production externality graph

Positive consumption externality graph

Subsidy diagram

Indirect tax diagram

Common pool resources

Goods that are rivalrous but non-excludable. These resources are not owned by anyone, do not have a price, and are available for anyone to use without payment; the depletion of these resources lead to environmental unsustainability.

Tragedy of the commons

Concept that illustrates the depletion and degradation of finite resources faster than they are replenished.

Pigouvian taxes

Form of tax imposed on activities that generate negative externalities.

Tradeable permits

Permits issued by the government to limit pollution.
These permits can be bought and sold in a market.

This reduces incentive to pollute because:

• Firms save costs by not purchasing additional permits

• Increase revenue by selling spare permits to other firms

Advantages and disadvantages of market-based policies

Pros:

Internalize the externality (external costs become private costs)
Tax on pollution better than tax on output (for firms who would face lower costs switching to alternatives, they reduce pollution)

Cons:
Difficult to identify pollutant and method of polluting
Difficult to measure amount of harm done and suitable amount of tax
Indirect taxes are regressive
Firms do not abide
Politically difficult to set high enough

Regulation (legislation)

Regulation is defined as legislation imposed by a government on individuals and private sector firms in order to regulate and modify economic behaviors.

Cons of legislation

Do not incentivize using less polluting resources, increasing energy efficiency, or looking for cleaner alternatives
Difficult to account for all pollutants

Collective self-governance

Refers to a system where users of common pool resources work together to solve and manage environmental problems.

Pros and cons of collective self-governance

Pros:
Does not rely on private or public resources

Cons:
Not always present (relies on goodwill of participants)
many common pool resources are globally and cannot be locally solved
depends on one’s income

Cons of education/ awareness creation

Has varying effects, depends on effectiveness of conveyed information
Does not help solving solutions that require action at a far broader scale (e.g: use of fossil fuels)

Demerit goods

Goods that are considered to be undesirable for consumers and are overprovided by the market. Reasons for overprovision are usually that the goods have negative consumption externalities; in addition there may be consumer ignorance about the harmful effects.

Cons of using direct provision / subsidies to correct positive consumption externalities

Choice must be made on what to support and how much to support
Difficult to measure external benefits
Can cause producer inefficiency
Different stakeholders benefit to different extents
BUT better than legislation/awareness because does not raise price for consumers

Public goods

Goods whose consumption does not reduce its availability to to others and does it is not possible to exclude them from using it (non-rivalrous, non-excludable)

Private goods

Goods whose consumption by one person reduces its availability to to others and it is possible to exclude them from using it(rivalrous, excludable)

Quasi-public goods

Goods whose consumption does not reduce its availability to others but you can exclude people from using it (non-rivalrous, excludable)

Resources

Factors of production such as land, labor, capital and enterprise used to produce goods.

Carbon tax

An indirect tax per unit of emissions to incentivize lower pollution (reduce negative externality/ address market failure).

How does direct provision / subsidy / price floor result in firm inefficiency?

Inefficient firms with high costs of production do not face incentives to cut costs by using more efficient production methods because the high price offers them protection against lower-cost competitors.