Microeconomics pt4/ Government intervention

PRICE CEILING AND FLOOR

Price controls

the setting of minimum or maximum prices by the government so that prices are not able to adjust to their equilibrium price. 

Price ceilings

maximum prices set by the government below the equilibrium price. 

Leads to shortage

What effect do price ceilings have?

Price ceilings have the effect of not allowing the price to rise above the one fixed by the government.  

Reasons for PC

• Make essential goods more affordable - Especially for low-income households (e.g., rent controls, food price controls)

• Protect consumers from price gouging - During emergencies or shortages

• Promote equity and fairness - Ensure basic necessities remain accessible to all

• Prevent exploitation - In markets with limited competition or monopoly power

• Address market failures

Things PC used for

• Fuel

• (Sometimes) medicine

• Rent control

Consequences of price ceiling (incentive, benefit, DWL)

• creates a shortage (TR goes down)

• Incentive:

• Allows for consumers to have more incentive to consume more because they are paying a price lower than the highets price they are willing to pay.

• Producers have less incentive to produce, due to reciving a lower price than the highest price they are willing to produce at.

• Benefit:

• The price ceiling will benefit the consumers that are able to get the good

  It will disadvantage those that will not be able to get the good because of the shortage. 

• The producers are at a disadvantage as it lowers the price for producers to produce at, which lowers the quantity they’re willing to supply and decreases TR. 

• - This is also seen as the consumer surplus increases while the producer surplus decreases

• DWL - what soceity loses due to underallocation of resoucres from the price ceiling imposed by the government on good x.

Other consequences of price ceiling

• Formation of black markets

• Reduction in quality as producers try to cut costs

• Under allocation of resources

Price floors

are minimum prices set by the government above the equilibrium price.

Leads to surplus

What effect do price floors have?

Price floors have the effect of not allowing price to go below the price fixed by the government. 

Reaons for PF

• Protect producer incomes - Especially in volatile markets like agriculture

• Ensure minimum living standards - Minimum wage laws for workers

• Support strategic industries - Protect domestic industries from foreign competition

• Prevent exploitation - In markets with monopsony power (single buyer)

• Maintain quality standards

What PF is used for

• Minimum wages

• Agricultural markets

• Alcohol markets

Consequences of price floor (Incentives, benefits, DWL)

• creates a surplus (TR MAY go up (only fs goes up if government buys surplus))

• Incentive:

• Producers have more incentive to produce, due to reciving a higher price than the lowest price they are willing to produce at.

• Allows for consumers to have less incentive to consume more because they are paying a price higher than the equalibrium price they are willing to pay.

• Benefit:

• The price ceiling will benefit the producers that are able to get the good

  It will disadvantage those that will not be able to afford to produce the good at this higher price/ produce excess product

• The consumers are at a disadvantage as they now pay a higher price to consume and so consume less quantity.

• - This is also seen as the producer surplus increases while the consumer surplus decreases

• DWL - what soceity loses due to overallocation of resoucres from the price floor imposed by the government on good x.

Other consequences of price floor:

• Inefficient allocation of resources (overproduction)

• Gov. expenditure if gov. buys the surplus (which leads to storage and exportation costs for surplus goods)

Gov. Spending / buying surplus of PF

• However much of the surplus consumers are not willing or able to buy - the government buys it instead.

• The government is spending more money than gained when purchasing the surplus

• Consequences:

• Gov. either exports the surplus or stores it - but there is an opportunity cost when doing these actions as it is money cant be spent on anything else (e.g healthcare)

• DWL - what soceity loses due to still the overallcation of resources but also because the govenrments decision to buy the surplus - meaning money spent on that and not other important things for soceity (e.g again healthcare)

TAXES AND SUBSIDIES

Indirect taxes

payments made to the government which are partly paid by consumers but are paid to the government by producers.

2 types of indirect tax

Excise tax - places on specific goods/services, e.g alcohol

Sales/Value added tax (VAT) - added on spending of most goods/services. VAT in Austria is 20%

Specific indirect tax

Per unit amount added to a good/service

Tax - PC over PP

Consumers: Worse off

• Incentivizes them to consumer less, as they now pay a higher price than equalibrium price and are demanding less quantity, seen as PC (amount more is PC-PE), and the new quantity being Qtax (amount less is Qe-Qtax)

• This could lead to the substitution affect - for consumers to switch to cheaper alternatives (depending on the elasticity of demand) - and also the Income effect - as it takes up more of income since the price increased, reducing purchasing power.

But consumer welfare could have a positive impact on it, if the good is a demerit good than the consumption of it decreases, leading to more positive impacts.

• Producers: Worse off

• S curve shitfs upwards by the amount of the tax, as it increases the cost of prodiction for producers

• Incentivizes them to produce less as they now recieve a lower price than equalibrium (seen as PP, amount less is PE-PP) and face higher costs of production, so produce less (seen as Qtax, amount less is Qe- Qtax).

• As a result, there is a decrease in revenue for the producer, being the inversely upside down L.

Both producer and consumer surplus decrease, both are worse off.