PM P2: Government Interventions in Markets

Why do Governments intervene in Markets? (Reasons for Intervention)

To resolve market failure or as a response to inequity.

What are Indirect Taxes?

Taxes on goods and services, paid by suppliers to tax authorities.

What is a Specific Tax?

Indirect tax of a fixed sum per unit sold. SS curve shifts parallel upwards by tax amount.

What is an Ad Valorem Tax?

Indirect tax of a certain percentage of the price. SS curve shifts upward pivotally (tax amount rises with price).

What is the Effect of Indirect Tax?

↑ COP -> ↓ Supply (SS shifts left/upward).

What is the Impact of Indirect Tax on P and Q?

P ↑, Q ↓.

What is the Impact of Indirect Tax on Consumer Surplus and Producer Surplus?

CS ↓, PS ↓.

What is the Impact of Indirect Tax on Government?

Gains tax revenue.

What is the Impact of Indirect Tax on Society? (without market failure)

Overall welfare loss (deadweight loss) due to under-allocation of resources.

What are Direct Taxes?

Taxes on income and wealth, paid directly by economic agents.

What is the Effect of Direct Tax?

↓ Disposable income -> ↓ ability/willingness to pay -> ↓ Demand (DD shifts left/downward).

What is the Impact of Direct Tax on P and Q?

P ↓, Q ↓.

What is the Impact of Direct Tax on Consumer Surplus and Producer Surplus?

CS ↓, PS ↓.

What are Subsidies?

Cash transfer from the government to the producer or consumer.

What are Indirect Subsidies?

Granted by tax authorities to suppliers of goods and services.

What is a Specific Subsidy?

Indirect subsidy of fixed sum per unit sold. SS curve shifts parallel downwards by subsidy amount.

What is an Ad Valorem Subsidy?

Indirect subsidy of a certain percentage of the price. SS curve shifts downward pivotally.

What is the Effect of Indirect Subsidy?

↓ COP -> ↑ Profitability -> ↑ Supply (SS shifts right/downward).

What is the Impact of Indirect Subsidy on P and Q?

P ↓, Q ↑.

What is the Impact of Indirect Subsidy on Consumer Surplus and Producer Surplus?

CS ↑, PS ↑.

What is the Impact of Indirect Subsidy on Government?

Incurs expenditure.

What is the Impact of Indirect Subsidy on Society? (without market failure)

Overall welfare loss (deadweight loss) due to over-allocation of resources.

What are Direct Subsidies (Consumption Subsidies)?

Financial aids provided directly to consumers (e.g., cash grants).

What is the Effect of Direct Subsidy?

↑ Consumers' ability to pay -> ↑ Effective demand (DD shifts right/upward).

What is the Impact of Direct Subsidy on P and Q?

P ↑, Q ↑.

What is the Impact of Direct Subsidy on Consumer Surplus and Producer Surplus?

CS ↑, PS ↑.

What is the Net Welfare Impact of Direct Subsidy?

Likely positive if well-targeted, achieves redistributive goal, avoids price inflation and fiscal strain.

What are Price Controls?

Government setting minimum or maximum prices to prevent adjustment to free market equilibrium.

What is a Minimum Price (Price Floor)?

Legally established minimum price, must be set ABOVE the market equilibrium price to be effective.

Why impose a Minimum Price? (Reasons for Minimum Price)

Protect producers' incomes, create surplus for storage, prevent wages falling (minimum wages).

What is the Effect of Minimum Price?

Creates a SURPLUS (Qs > Qd) -> over-allocation of resources.

What factors affect the size of Surplus from Minimum Price? (Factors affecting Surplus)

Level of price floor ↑ -> greater surplus. PED/PES ↑ -> greater surplus. DD ↓ / SS ↑ -> surplus increases.

What is the Impact of Minimum Price on P and Q? (with govt buyback)

P ↑ to floor, Q traded ↓ (Qd). Govt buys surplus.

What is the Impact of Minimum Price on CS and PS? (with govt buyback)

CS ↓, PS ↑.

What is the Impact of Minimum Price on Government? (with govt buyback)

Incurs expenditure to buy up surplus.

What is the Impact of Minimum Price on Society? (without market failure)

Overall deadweight loss due to overproduction.

What is a Maximum Price (Price Ceiling)?

Legally established maximum price, must be set BELOW the market equilibrium price to be effective.

Why impose a Maximum Price? (Reasons for Maximum Price)

Achieve equity (make necessities affordable, e.g., rent controls, food price controls).

What is the Effect of Maximum Price?

Creates a SHORTAGE (Qd > Qs) -> under-allocation of resources.

What factors affect the size of Shortage from Maximum Price? (Factors affecting Shortage)

Level of price ceiling ↓ -> greater shortage. PED/PES ↑ -> greater shortage. DD ↑ / SS ↓ -> shortage increases.

What is the Impact of Maximum Price on P and Q?

P ↓ to ceiling, Q traded ↓ (Qs).

What is the Impact of Maximum Price on CS and PS?

CS change uncertain (potential gain/loss), PS ↓.

What are Unintended Consequences of Max Price?

Non-price rationing (queues, limited coupons), underground/black markets.

What are Quantity Controls?

Government setting fixed output level.

What is a Quota?

A limit on the quantity produced imposed by the government, must be set BELOW the market equilibrium quantity to be effective.

What is the Effect of a Quota?

Q traded ↓ to quota limit. P ↑ to P consumers are willing to pay for limited quantity.

What is the Impact of a Quota on CS and PS?

CS ↓, PS may ↑ or ↓ depending on specific values.

What is the Impact of a Quota on Society?

Overall deadweight loss due to under-allocation of resources.