Chapter 21

Government Microeconomic Intervention

• Market Failure: Inefficient distribution of goods and services in the free market.

  • Causes of Market Failure:

    • Negative production externalities

    • Negative consumption externalities

    • Positive production externalities

    • Positive consumption externalities

Negative Production Externalities

• Occur when production creates external costs not reflected in the price of goods.

  • Results in overproduction due to only considering private costs.

  • Marginal External Cost (MEC): The cost imposed on society, not reflected in the market price.

    • Ideal situation: Indirect tax = MEC

Measures to Tackle Negative Production Externalities

1. Specific Indirect Tax: A fixed rate tax on the sales of goods. Effects include:

   • Shifts the supply curve left (from P0 to P1 and Q0 to Q1).

   • Tax revenue = area AB (portion of tax paid by consumer) + B (portion by producer).

2. Ad Valorem Tax: A percentage of the price charged as tax.

3. Regulation: Government legal requirements increase production costs for firms.

4. Property Rights: Determine rights over asset use to mitigate pollution.

   • Options:

     • Polluting firms hold rights: compensated to stop pollution.

     • Affected parties can sue but rely on bargaining power.

5. Pollution Permits: Licences to pollute up to a limit, can be traded.

6. Licensing: Allows firms to operate in specific markets. Types:

   • Exclusive: Only one firm holds the license.

   • Non-exclusive: Multiple firms can operate with lower fees.

Negative Externalities in Consumption

• Leads to spillover costs where Marginal Social Benefit (MSB) is lower than Marginal Private Benefit (MPB).

  • Indicates over-estimated supply due to unconsidered MEC.

Measures for Negative Consumption Externalities

1. Indirect Tax: Discourages purchasing through increased prices.

2. Minimum Price Controls: Reduces demand for demerit goods by setting prices above equilibrium.

3. Provision of Information: Educates consumers regarding negative effects of demerit goods.

4. Production Quotas: Limits supply to control demand.

Positive Production Externalities

• Spillover benefits produced that are not accounted for in prices.

  • Leads to underproduction due to lack of firm incentives.

Measures to Realise Positive Production Externalities

1. Subsidies: Financial aids that increase supply, reducing prices and enhancing social benefits.

2. Provision of Information: Informs firms about long-term benefits of producing merit goods.

Positive Consumption Externalities

• Decisions impacting consumers favorably, leading to increased overall consumption.

Measures for Positive Consumption Externalities

1. Direct Provision of Information: Informs consumers about benefits of merit goods.

2. Subsidies: Reduce retail prices to boost consumption.

3. Nationalisation: Government assumes control of private sectors to enhance supply of public goods.

4. Privatisation: Transfers public businesses to the private sector to improve competition and efficiency.

5. Deregulation: Removes restrictions to enhance market freedom.

6. Nudge Theory: Influences economic behavior through indirect manipulation (eg. awareness).

Government Failure in Microeconomic Intervention

• Government Failure: Inefficiencies caused by government attempts to correct market failures.

Causes of Government Failure

1. Imperfect Information: Policies require accurate data; inaccuracies lead to inefficiencies.

2. Unintended Consequences: Solutions may create new issues through misunderstanding market behavior.

3. Undesirable Incentives: Taxes may dissuade work or product demand; political goals may overshadow economic welfare.

4. Policy Conflict: Measures like taxes may increase income inequality.

Consequences of Government Failure

• Deadweight Loss: Results in suboptimal consumption/production.

• Reduced Consumer Surplus: Higher prices discourage consumption.

• Decrease in Economic Welfare: Leads to reduced competition and efficiency.

Equity and Redistribution of Income and Wealth

• Equity: Fair distribution tailored to individual circumstances.

  • Horizontal Equity: Same circumstances pay the same tax.

  • Vertical Equity: Fair tax distribution between rich and poor.

• Equality: Equal resources and opportunities for all.

• Types of Poverty:

  • Extreme Poverty: Below the international poverty line ($2.15/day).

  • Absolute Poverty: Insufficient income for basic needs.

  • Relative Poverty: Income below a certain percentage of average household income.

Policies Towards Equity and Equality

1. Universal Benefits: Available regardless of need but costly.

2. Means-tested Benefits: Aimed at low-income individuals to reduce poverty traps.

3. Negative Income Tax: Single system for tax and benefits to simplify financial incentives.

4. Universal Basic Income: Regular unconditional income for all citizens.

5. Progressive Tax: Increases tax rate more than proportionately with income.

6. Regressive Tax: Decreases tax rate as income increases.

Labour Market Forces and Government Intervention

Demand for Labour

• Labour Demand: Reflects the need for workers based on product demand.

  • Factors include wage rate, productivity, and demand for the product.

• Labour Demand Curve: Movement reflects firm’s willingness to employ based on market conditions.

Supply of Labour

• Supply of Labour: Number of hours workers are willing to work at a given wage.

• Influenced by wage rates and non-wage factors (e.g., job satisfaction).

Movement and Shifts in Labour Supply Curve

• Movement due to wage changes; shifts due to factors like population changes and retirement age.

Wage Determination in Perfect and Imperfect Markets

Perfect Market

• Equilibrium wages determined by supply and demand.

Imperfect Market

• Influenced by government/union interventions and can lead to issues such as monopsony employment practices.

Wage Differentials

• Differences in pay exist for the same job due to:

  • Experience and education

  • Industry types and demands for skills

Transfer Earnings and Economic Rent

• Transfer Earnings: Minimum payment required for labor to stay in its current role.

• Economic Rent: Above-minimum payment reflecting the scarcity of labor.