Government Intervention

Indirect Tax
1. Why?
  1. 1. government revenue
  2. 1. increase government revenue
  3. 2. decrease the usage of a product
  4. 3. indirectly collect taxes from the rich to strengthen the middle class
2. Market Outcome
  1. equilibrium quantity produced and consumed falls from Q* to Qt
  2. equilibrium price increases from P* to Pc, which is the price paid by consumers
  3. consumer expenditure on the good is given by the price of the good per unit times the quantity of units bought; it therefore changes from P* × Q* to Pc × Qt
  4. price received by the firm falls from P* to Pp, which is Pp = Pc − tax per unit
  5. the firm’s revenue falls from P* × Q* to Pp × Qt
  6. the government receives tax revenue, given by (Pc − Pp) × Qt, or the amount of tax per unit times the number of units sold; this is the shaded area
  7. there is an underallocation of resources to the production of the good: Qt is less than the free market quantity, Q*.
3. Effects on Stakeholders
  1. Consumers are worse off (market price for them rises and there is a smaller quantitiy available)
  2. Suppliers are worse off (fall in received price and quantity they sell)
  3. Workers are worse off: A lower amount of output means that fewer workers are needed to produce it, therefore workers become unemployed.
  4. Government is better off (receives tax revenue)
  5. Society is worse off (under-allocation of resources)
Subsidies
1. Why?
  1. To increase the revenue of a producer and reduce cost of production
  2. To make necessities available to low income consumers
  3. To promote the produce of merit goods
  4. to support the growth of particular industries in an economy
  5. Subsidies can be used to encourage exports of particular goods
2. Market Outcome
  1. equilibrium quantity produced and consumed increases from Q* to Qsb
  2. the equilibrium price falls from P* to Pc; this is the price paid by consumers
  3. the price received by producers increases from P* to Pp
  4. the amount of the subsidy is given by (Pp − Pc) × Qsb this is the entire shaded area, and represents government spending to provide the subsidy
  5. there is an overallocation of resources to the production of the good: Qsb is greater than the free market quantity, Q*.
3. Effects on Stakeholders
  1. Consumers are better off (the price they pay reduces and quantity available to them rises)
  2. Producers are also better off, because they receive a higher price and produce a larger quantity. The price and quantity effects translate into an increase in revenues.
  3. Workers are better off: As output expands, firms are likely to hire more workers to produce the extra output.
  4. The government is worse off (has to use its own budget to pay for the subsidy)
  5. Society as a whole is worse off because there is an overallocation of resources to the production of the good
Price Controls
1. Price Ceiling
  1. Why?
    1. to make necessities available to low income consumers
  2. Market Outcome
    1. fall in price causes a drop in quantity supplied and an increase in quantity demanded (law of supply and demand)
    2. this causes a shortage (excess demand) which is a disequilibrium.
  3. Consequences for Economy
    1. Shortage: not enough of the good being supplied, excess demand
    2. Non-price Rationing: 1. waiting in line and the first-come-first-served 2. the distribution of coupons to all interested buyers, so that they can purchase a fixed amount of the good in a given time period 3. favoritism
    3. Underground Markets: buying a good at the maximum legal price, and then illegally reselling it at a price above the legal maximum.
    4. welfare loss (deadweight loss), or lost social benefits due to the price ceiling.Welfare loss represents benefits that are lost to society because of resource misallocation.
  4. Effects on Stakeholders
    1. Consumers partly gain and partly lose.Those consumers who are able to buy the good at the lower price are better off. However, some consumers remain unsatisfied as at the ceiling price there is not enough of the good to satisfy all demanders.
    2. Producers are worse off, because with the price ceiling they sell a smaller quantity of the good at a lower price; therefore, their revenues drop
    3. Workers are worse off because fall in output results in workers being fired, unemployment rises
    4. the government may gain in political popularity among the consumers who are better off due to the price ceiling.
2. Price Floor
  1. Why?
    1. to protect low income producers such as farmers.
  2. Agricultural Price Floor
    1. Market Outcome
      1. The price floor results in a larger quantity supplied, Qs, than the quantity supplied at market equilibrium, Qe. In addition, the price floor, Pf, leads to a smaller quantity demanded and purchased than at the equilibrium price: the quantity consumers want to buy at Pf is Qd, which is smaller than the quantity Qe that they bought at price Pe. A price floor does not allow the market to clear; it results in disequilibrium where there is a surplus (excess supply). A common practice is for the government to buy the excess supply, and this causes the demand curve for the product to shift to the right to the new demand curve ‘D plus government purchases’.
    2. Consequences for the Economy
      1. Surplus: not enough demand, excess supply
      2. Government measures to dispose of surpluses: storage, export, send as aid, all problematic
      3. Firm inefficiency Higher than equilibrium product prices can lead to inefficient production;
      4. Overallocation of resources
      5. creates welfare (deadweight) loss, indicating that the price floor introduces allocative inefficiency due to an overallocation of resources
    3. Effects on Stakeholders
      1. Consumers are worse off, as they must now pay a higher price for the good while they buy a smaller quantity of it
      2. Producers gain as they receive a higher price and produce a larger quantity, and since the government buys up the surplus, they increase their revenues
      3. Workers are likely to gain as employment increases on account of greater production of the good.
      4. government is worse off because it buys the excess supply, this is a burden on its budget
  3. Minimum Wage
    1. Market Outcome
      1. The minimum wage, Wm, lies above the equilibrium wage, We. Therefore, at Wm, the quantity of labour supplied, Qs, is larger than the quantity of labour supplied when the labour market is in equilibrium (Qe). The quantity of labour demanded, Qd, is less than the quantity demanded at equilibrium, Qe. There results a surplus of labour in the market equal to the difference between Qs and Qd.
    2. Consequences for the Economy
      1. Labour surplus (excess supply) and unemployment
      2. Illegal workers at wages below the minimum wage
      3. Misallocation of labour resources: industries that rely heavily on unskilled workers are more likely to be affected, and will hire less unskilled labour.
      4. Misallocation in product markets Firms relying heavily on unskilled workers experience an increase in their costs of production, leading to a leftward shift in their product supply
    3. Effects on Stakeholders
      1. Firms are worse off as they face higher costs of production due to the higher labour costs.
      2. The impacts on workers are mixed. Some gain, as they receive a higher wage than previously but some lose as they lose their job.
      3. Consumers are negatively affected, because the increase in labour costs leads to a decrease in supply of products causing higher product prices and lower quantities.

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Government Intervention

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