Government and the Market: Price Controls, Taxes, and Market Allocation

Flashcards covering price ceilings, price floors, tax and subsidy incidence, and non-market allocation mechanisms based on lecture slides.

What are the three main justifications for a government setting a minimum price (a price floor)?

To protect producers’ incomes, to create a surplus, and to deter the consumption of a particular good.

What methods can a government use to deal with surpluses created by a minimum price?

Buying and storing the goods, destroying them, selling them abroad, imposing quotas on the quantity produced, or raising demand through advertising.

What are the main drawbacks of minimum prices as a control measure?

1. Firms with unsold surpluses may try to evade the control by cutting prices illegally.
2. Firms may feel less need to cut costs or adopt efficient production methods because their profits are protected.
3. High prices may discourage firms from producing alternative goods that they could produce more efficiently or that are in higher demand.

What is the primary justification for a maximum price (price ceiling), and what non-price allocation methods may arise due to the resulting shortage?

The justification is fairness. When shortages occur, goods may be allocated via: a “first-come, first-served” basis, random ballot, favoured customers, a measure of merit, rules or regulations, and rationing.

What are the two major market problems created by maximum prices, and what four solutions can governments implement?

Problems: The emergence of illegal markets and a reduction in the quantity produced of an already scarce good. Solutions: Direct government production, subsidies or tax relief to firms, provision of alternative goods, and income control.

In the 2017 London Marathon example, how many applicants applied at the £35 fee, and how many places were available to them?

$253\,000$ applicants applied at £35, but only $17\,500$ places were available for those applicants (out of $40\,000$ total places).

How did the registration policy for the London Marathon public ballot change between 2015 and 2016?

In 2015, entry was capped at the first $125\,000$ online registrants. Because it took only eight hours to reach this limit, the cap was removed in 2016 and replaced by a fixed registration window, typically lasting five days at the start of May.

What are the advantages of using the "Good for Age" allocation method for the London Marathon?

It allocates places to committed runners who place a higher value on the event, and it aids organization by spreading out finish times so the majority of runners do not finish all at once.

According to the qualifying times table, what were the 2022 TCS London Marathon Championship qualifying standards for men and women?

Full marathon: sub $2:40:00$ for men and sub $3:14:00$ for women. Half marathon: sub $1:12:30$ for men and sub $1:28:00$ for women.

How do Golden and Silver Bond charity schemes operate to allocate places in the TCS London Marathon?

Charities receive set allocations of places and distribute them to runners who commit to raising a specified minimum amount of money. If runners fail to raise the minimum, they must pay the difference out of their own pocket in addition to the standard entry fee.

What three regulatory caps were placed on the UK payday loan market in January 2015?

1. Interest rates were capped at $0.8\%$ per day.
2. Charges for late repayments were capped at a maximum of £15.
3. The total amount charged to borrowers (even upon default) was limited to double the original loan amount.

Using this diagram of the payday loan market, explain why the legal price cap ($P_c$) led to the development of an illegal market.

Because borrowers are willing to pay up to price $P_2$ for quantity $Q_1$, some lenders choose to break the law by charging prices higher than the cap $P_c$ (up to $P_2$) to clear the unmet demand.

How do a specific tax and an ad valorem tax differ in their definitions and their shifts of the supply curve?

A specific tax is a fixed monetary charge per unit sold (e.g., fuel duty), causing a parallel upward shift of the supply curve. An ad valorem tax is a set percentage of the good's price (e.g., VAT), causing the supply curve to pivot upwards with a wider monetary gap at higher prices.

How does the price elasticity of demand affect the consumer's share of an indirect tax?

The consumer's share of the tax burden is greater the less elastic (more inelastic) the demand, and smaller the more elastic the demand.

How does the price elasticity of supply affect the producer's share of an indirect tax?

The producer's share of the tax burden is greater the less elastic (more inelastic) the supply, and smaller the more elastic the supply.

What is the policy dilemma governments face regarding tobacco taxation?

Tobacco has high, inelastic demand, making it an effective source of government tax revenue. However, if government health campaigns successfully discourage smoking, this tax revenue decreases.

What are three problems associated with continually raising tobacco taxes?

1. Increased smuggling and black-market crime.
2. A disproportionate financial impact on lower-income segments of society.
3. Demand for tobacco becoming more price elastic over time.

How do elasticities determine the incidence (distribution of benefit) of a production subsidy?

The producer's share of the subsidy is greater the less elastic the supply and the more elastic the demand. The consumer's share is greater the less elastic the demand and the more elastic the supply.

True or False: Whenever goods or services are provided free at the point of use, there will always be a shortage.

False.

What is the key difference between the market impact of an indirect tax and the impact of making a good illegal?

Both shift the supply curve upwards/leftwards, but making a good illegal also shifts the demand curve to the left, whereas a tax leaves the demand curve unchanged. Consequently, a tax requires a much larger shift in supply and results in a higher price to achieve the same reduction in consumption as prohibition.

Under what conditions would making a good illegal cause its market price to fall?

When the leftward shift in demand is greater than the leftward shift in supply (for example, if consumers are exceptionally law-abiding or face harsher penalties than suppliers).

Why do governments choose prohibition rather than heavy taxation for illegal drugs?

Prohibition sends a strong moral signal of social disapproval (taxation implies legal and social acceptability), and taxes set high enough to reach equivalent consumption drops would spur extensive tax evasion and large black markets.