2.7 Role of government intervention

Price Ceiling

When the government sets a maximum price below the equilibrium price

Demerit good

Goods that damage the individual and/or society as a whole, but are over provided by the market

Price ceiling diagram

Reasons/adv for price ceiling

1. Increase consumption

2. To reduce the price of the good for low-income consumers

Costs/disadv of price ceiling

1. Excess demand/Shortages

2. Rationing Problem Impossible to create a perfectly rationing fair system as there is a shortage

3. Emergence of Black Market

Price Floor

When the government sets a minimum price above the equilibrium price

Price floor diagram (for goods)

Price floor diagram (for minimum wage)

Reasons/adv for price floor

1. Agricultural Products

2. Minimum Wage

3. Demerit goods

Costs/disadv of price floor

1. Emergence of black markets

2. Excess supply

3. Firm inefficiency

Indirect tax

A tax imposed upon expenditure

Placed upon the selling price of the product and is paid by consumers/producers when a good/service is bought

Tax diagram

Reasons/adv of tax

1. Collect government revenue

2. Discourage consumption of demerit goods

3. Redistribute income through luxury goods

4. Reduce impact on society/environment

Costs/disadvantages of tax

1. Consumer surplus decrease

2. Producer surplus decrease

3. Increased unemployment

4. Total social surplus decrease

Tax burden diagram for goods with inelastic PED

Tax burden diagram for goods with elastic PED

Effectiveness of tax for different PED

Inelastic: good for increasing govt revenue, bad for discouraging demand

Elastic: good for discouraging demand, bad for increasing govt revenue

Subsidy

A sum of money granted by the government and paid to producers, to help an industry or business keep the price of a good or service low

Subsidy diagram

Reasons/adv of subsidy

1. Lower the price of the essential basic items

2. Protecting jobs/industry and domestic firms

3. Increase production/supply of essential services or products

4. Boosting the economic growth by funding infrastructure projects

5. Increase consumption of merit good

Costs/disadv of subsidy

1. Increased govt expenditure

2. Opportunity cost of subsidy

3. Taxpayers bear high expenditure

4. Overallocation of resources

5. Environmental waste from excess supply

6. Firm inefficiency

7. Potential equity issue