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)