Chap 3 - Government intervention

Government intervention

• When the gov gets involved in markets to correct market failure & improve economy efficiency.

Market failure

• A market that fails to allocate scare resources efficiently.

Reasons for gov intervention

1. Public goods provision

   • No incentive to pay

   • No profits & provision from private sector

2. Merit & Demerit goods

3. Inappropriate prices

Methods of gov intervention

1. Indirect tax

   • Specific tax

   • Ad valorem tax

2. Subsidies

3. Maximum price

4. Minimum price

5. Buffer stock

6. Direct provision of goods & services

7. Provision of information

Method of intervention - Indirect taxes

• Tax that is levied on goods & services

• Paid by suppliers of the product to tax authorities

• Study graph, consumer/producer incidence of tax

Indirect taxes: Specific tax

• Per unit tax on each product

• Causes a parallel shift of the supply curve to left.

Indirect taxes: Ad valorem tax

• Percentage tax on the value of goods & services.

• Causes the S-curve to pivot, instead of shift.

Advantages of taxation

1. Consumption & Production of demerit goods ⬇

2. Price ⬆, Quantity trades ⬇

3. Welfare ⬆

4. Tax revenue ⬆

Disadvantages of taxation

1. Difficult to measure the harmful effects of demerit goods

2. Makes domestic industries less competitive

3. Burdens low income households

4. Ineffective when PED is inelastic

5. Expensive to collect taxes

6. Leads to inflation.

Method of intervention: Subsidies

• A payment by the government to consumers or producers to encourage the consumption & production of a good.

• GO study your graph, burden on consumer and producer opposite to tax

Advantages of subsidy

• To keep market prices of essential goods low

• To encourage consumption of merit goods

• Better distribution of income

• Raise producer income

Disadvantages of subsidy

1. OC to government

2. May be set too low or too high

3. May cause over-reliance of firms on gov

4. May not be passed onto consumers

5. May be ineffective when PED inelastic (people X buy more despite low price)

Method of intervention: Maximum price

• To prevent market price from rising above a certain level.

• study graph hoho, shortages hoho

Advantages of maximum price

1. Consumption ⬆

2. Affordability to poor ⬆

3. To counterbalance monopoly

Disadvantages of maximum price

1. Shortages

2. Non-price rationing

   • Queuing

   • Distribution of coupons (buyers can buy limited no. of goods)

   • Favoritism

   • Underground/Informal markets

Method of intervention: Minimum price

• To prevent market price from falling below a certain level.

• Study graph hoho, surplus hoho

Advantages of minimum price

1. Consumption ⬇

2. Income producer ⬆

Disadvantages of minimum price

1. Surplus

2. Overallocation of resources

Method intervention: Buffer stocks

• A price stabilization scheme that requires the government to purchase a particular good when it is in surplus, and sell it when it is in shortage to maintain a stable market price of the good.

• Check graph, just shifting S-curve only

Advantages of buffer stock

1. Stabilize farmer’s income

2. Stability invites capital investment.

3. Stable prices for consumers

Disadvantages of buffer stock

1. Storage & transport is expensive

2. Difficult to know the appropriate quantity of goods needed to purchase or sell to stabilize market price.

3. Only works for non-perishable goods.

Method of intervention: Direct provision of goods & services

• Government provides particular goods & services

• Low income earners gain the most

• OC to gov as need tax revenue

Method of intervention: Provision information

• government informing consumers and producers on accurate information regarding the goods in an economy

Income & Wealth

1. The flow of wages, salaries and earning from other sources in a period.

2. The stock of accumulated assets

Gini coefficient

• A numerical measure of income inequality.

• Between 0 to 1

• The⬆ the number, the ⬆ the degree of income inequality

Emerging countries

• Advancing countries that develops faster than even developing countries.

Reasons for inequality

1. Decline in trade union power

2. Lack of skill

3. Lack of employment opportunities

4. Inheritance

5. Age structure of population

   • No. of old people ⬆

   • Availability of pension ⬇

   • Old people w no income ⬆

Policies to redistribute income & wealth

1. Minimum wage

2. Direct tax

   • Progressive tax

   • Inheritance tax

   • Capital tax

3. Transfer payments

4. Provision of goods and services

Policy to redistribute income & wealth: Minimum wage

• A minimum level of pay laid down by law, that employers should legally pay their workers to ensure a reasonable standard of living.

• Graph is just minimum price graph

Policy to redistribute income & wealth: Transfer payment

• Government payments of income which are not a return for the provision of any factor of service.

• may create disincentive to work

Policy to redistribute income & wealth:

Direct tax - Progressive tax

• Taxes on the incomes of consumer and firms.

• Proportional of total paid tax rises as income rises.

Policy to redistribute income & wealth:
Direct tax - Inheritance tax

• Taxes on the incomes of consumer and firms.

• A progressive tax on an inheritance.

Policy to redistribute income & wealth:

Direct tax - Capital tax

• Taxes on the incomes of consumer and firms.

• A progressive tax on the profit made by selling capital.