Government intervention in the market

Why does the government intervene in a market?

  • Market price is considred too high (rent)

  • Market price is considered too low (clothes)

  • Quantity supplied is considered too high (plastic)

  • Quantity supplied is considered too low (schools)

There are 3 types of market intervention including:

  1. Market-based interventions → prices floors/ceilings (price intervention), taxes and subsidies (quantity intervention)

  2. Regulations → laws

  3. Provision of merit goods (goods with a positive externality)→ public schools, hospitals, etc.

Price intervention

Price Floor (Market price is consiered too low)

  • sets a minimum price that the good can be sold at

  • above equilbrium which is deemed socially undesirable

  • price floor, a change in the price of the good itself→ demand contracts, supply expands. Result: the market does not clear.

  • Demand does not equal supply, excess in supply, e.g, unemployment too much supply, not enough demand

Price Ceiling (Market price is considered too high)

  • the maximum price (ceiling) is imposed by the government

  • imposed below equilibrium becausre the market price it too high to be socially desirable

  • supply contracts and demand expands

  • disequilibrium, market has not cleared

  • excess in demand, e.g., rent control, homeless→ caused by too high rent

Quantity intervention

too high:

Taxes:

  • market quantity is consered too high, so the government intervenes with the aim to reduce quantity, supplied or demanded

  • Taxes are a disincentive to produce, decreasing the quantity supplied.

How does it work?

Taxes imposed on producing goods cause an increased price → this results in a decreased quantity and a new market equilbrium, overall reducing the quantity

too low:

Subsidies: cash payment per unit of production to producers

→ the supply curve represents the individual cost of production for firms (thier private cost, hence private cost curve)

Market Failure:

What is a public good? A good that is both non-excludable and non-rival, meaning that once provided, it is difficult to prevent people from using it, regardless of whether they pay for it.

For example: the defence force, the police force, a lighthouse, flood levee, etc.

(Private good: excludable, rival)

Market failure, when the private cost curve fails to account for the cost or benefit of a good and instead only it’s utility or benefit, results in socially undesirable outcomes in which supply is over/under produced and prices are too high/low, meaning that it is therefore undesireable.

S: an over supply of demerit goods (Negative externality) or an undersupply of merit goods

D:price is too high (products with positive externalities) or price is too low (products with negative externalities.

Government intervention is then used to address these issues.