Government Intervention, Distribution, and Macroeconomic Fundamentals – Lecture Review

What are the two defining characteristics of a public good?

It is non-rivalrous (one person’s use does not reduce availability to others) and non-excludable (no one can be prevented from using it).

Why do public goods give rise to the ‘free-rider’ problem?

Because people can enjoy the benefits without paying, so private firms lack profit incentive to supply them.

Give three examples of pure public goods often provided by government.

Street lighting, national defence, lighthouse services (radio transmissions may also be cited).

Define a demerit good.

A good considered harmful, generating negative externalities so that social cost exceeds private cost.

Define a merit good.

A good society believes people should consume regardless of ability to pay; it creates positive externalities so that social benefit exceeds private benefit.

State two government policies to curb over-consumption of demerit goods.

Indirect (excise) taxes and legislation/regulation (e.g., bans, age limits).

State two government policies to encourage consumption of merit goods.

Subsidies and compulsory provision/legislation (e.g., compulsory schooling, vaccination campaigns).

What is a maximum price (price ceiling)?

A legal highest price set below equilibrium to make a good more affordable.

At a binding price ceiling, what market condition occurs?

Excess demand (shortage), because quantity demanded exceeds quantity supplied.

Name two secondary consequences of a binding price ceiling.

Rationing mechanisms (coupons/queues) and emergence of black markets.

Who typically gains from a price ceiling and who loses?

Some consumers who obtain the good at a lower price gain; rationed-out consumers and producers generally lose; overall welfare loss occurs.

What is a minimum price (price floor)?

A legal lowest price set above equilibrium to raise producers’ incomes.

What market imbalance is created by a binding price floor?

Excess supply (surplus/glut) because quantity supplied exceeds quantity demanded.

Give two common examples of price floors.

Agricultural price supports and statutory minimum wages.

Define a specific (per-unit) indirect tax.

A fixed monetary amount levied on each unit sold, shifting supply upward by that amount.

How does an ad-valorem tax differ from a specific tax?

It is levied as a percentage of the good’s value; the tax per unit rises with price, causing a steeper supply curve.

When demand is relatively inelastic (PED<1), on whom does most of a specific tax burden fall?

Consumers, who face a larger price increase than producers’ price fall.

When demand is relatively elastic (PED>1), who bears more of the tax burden?

Producers, because raising price would lose many sales.

State two potential problems of imposing indirect taxes.

Welfare losses (deadweight) to consumers/producers and possible inflationary impact on essential goods with inelastic demand.

List three benefits governments may seek from indirect taxes.

High revenue generation, discouragement of demerit goods, and internalising negative externalities (e.g., pollution).

Define a subsidy