2.3 - government interventions, price floor/ceilling, subsidies, taxes

reasons for government interventions into the market

• to support firms

  • intervene to support key industries

• to promote equity

  • intervene to reduce opportunity gap between rich and poor

• to collect government revenue

  • provision of essential services, public and merit goods

• to support poorer households

• to correct market failures

  • intervene to influence level of consumption/ production

methods of government interventions

• indirect taxes

• subsidies

• price controls

  • price ceilling

  • price floor

taxes types

• direct

  • income tax

• indirect

  • goods and services tax

direct taxes types

• progressive (more you earn more you pay, tax brackets)

• flat/ fixed

• regressive (more you earn less you pay)

indirect taxes types

• general taxes (on all goods and services)

• excise taxes

  • on alcohol

  • tobacco

  • sugar

indirect taxes

• imposed on government causing supply curve to shift left

ad valorem VAT indirect tax

amount of good/service↑ = tax↑

specific indirect tax

fixed tax per unit of output

welfare loss

cost to society caused by the lack of efficiency in the allocation of resources

advantages of indirect taxes

• raises price and lowers demand for demerit goods

• raises revenue for government

disadvantages of indirect taxes

• tax may be ineffective on demerit goods

• helps develop illegal/ grey markets

• may lead to staff layover due to lower demand

subsidies

financial assistance given by the government

• to increase production

• to increase provision of merit goods

• to reduce costs

• to support employment

advantages of subsidies

• financial benefits for producers

• lowers prices for consumers

• increases supply of merit goods

• wealth redistribution

  • may benefit lower-income individuals

• encourages economic growth.

disadvantages of subsidies

• opportunity cost

• over-dependency

  • may stifle innovation and efficiency improvements

• fairness concerns

• mis-allocation of resources

  • fossil fuel subsidy may discourage investment in green energy

• environmental and social impacts

price controls

government regulations that set maximum or minimum prices for goods and services to stabilize the economy.

price ceiling

government-set maximum price that can be charged for a good or service

• to protect consumers from excessively high prices.

government use of price ceiling

• long period of time

  • rent control

  • medicine for chronic conditions

• short period of time

  • to stabilize markets that have increased prices due to unusual context

advantages of price ceiling

• increased consumer surplus

  • benefit from lower prices

• can protect vulnerable consumers during disasters

• can prevent monopolies from setting excessively high prices

disadvantages of price ceiling

• shortages

• decreased producer surplus

• reduces quality

• wastage/ over-consumption/ inefficient allocation of scarce resources

• creation of illegal/ grey markets

• government may have to supply the product to meet the excess demand of necessities

fixed supply and price ceiling (concert tickets)

price floor

• a minimum price set by the government to prevent prices from being too low

• to ensure producers have a fair price

• often applied in agricultural markets

government use of price floor

• help producers earn more in times of crisis

• decrease consumption of a demerit good

• to protect workers from wage exploitation

  • minimal wage

advantages of price floor

• increased producer surplus

• minimal compensation secured for suppliers

• prevention of price fluctuations and market stability

disadvantages of price floor

• supply surplus

• decreased consumer surplus

• potential unemployment

• increased prices for consumers

• black markets may emerge.

minimum wage

advantages of minimum wage

• increased income for workers

• reduction of poverty

• improved worker productivity and morale.

disadvantages of minimum wage

• potential job loss

• higher costs od production

• reduced demand for low-skilled labor