2.7.1 The reasons for government intervention
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Almost every economy will have government intervention to varying degrees.
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The reasons can be-
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Eliminate market failure, Every market will never be able to perform most optimally from both public and private interests, practically speaking, so governments can intervene to alter the level of production. Governments apply indirect taxes on purchases of cigarettes, alcohol and such demerit goods, to dissuade purchases and consumption of such goods
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The indirect taxes are also applied to Increase government revenue, which is another reason for government intervention. In fact the main reason behind implementation of indirect taxes on cigarettes and alcohol is to increase government revenue as we know these goods are addictive and have inelastic ped.
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Promoting equality and equity is a reason for government intervention as an ideal economy would have all citizens receiving equal opportunities. **equity is normative thus we can’t quite explain it as rule of thumb**Such policies can be Minimum wage legislations, carbon credits.
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Supporting firms or industries is a reason for government intervention. For example sunrise and sunset industries may require subsidies to remain competitive in global markets, and competition from MNCs
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Helping poverty stricken population is also an important reason, policies like National minimum wages, progressive taxation[ taxes that increase with income], unemployment benefits, etc.
2.7.2 Types of indirect tax
Specific Tax[Taxation per unit of the good]
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The equilibrium was P1Q1, which becomes P2Q2
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We can also see due to this both consumer and producer surplus reduces, as price producer receives is now P3.
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The tax received by the government is [P2-P3]x Q2
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The area of A is the incidence of tax on the consumers
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The area of B is the incidence of tax on the producer
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The supply curve shifts left because the profit margins for producers have gone down/ costs have increased.
Dead-weight loss in specific tax
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This triangle is the social surplus that is lost; this could have been generated if there was no tax.
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This is called deadweight loss.
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This is the area of the triangle.
Added tax[VAT, GST]
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A percentage tax of the total purchase price.
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The original equilibrium is P1Q1, which becomes P2Q2
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The new supply curve is more inelastic as costs increase as prices increase, opposed to specific tax being a specific amount per unit.
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Again the surpluses of consumer and producer decrease and government tax is [P2-P3] x Q2
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Deadweight loss can be found with the same method as for specific tax
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In both cases if the contraction in QD is significant enough, iyt may lead to the company having to fire some workers to reduce costs.
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VAT taxes are much more useful to increase government revenue, and both taxes can work to reduce market failure.
2.7.3 Price Controls
Price Ceiling
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Price Ceiling; A legal maximum price for the sale of goods, these will only be effective if set below the current equilibrium price. These are used to prevent exploitation of consumers and can be implemented for long term or short terms depending on the problem.
Price Ceilings
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Due to price controls, there is no new equilibrium as we can see due to the excess demand.
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To prevent this, often governments can purchase the products from the producers at higher prices[quantity=excess demand] and supply in the market at the ceiling price or free of charge, or production can be subsidised.
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Governments can also apprise producers to maintain their production level before enacting price ceilings to prevent shortages
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Evidently the consumer surplus will increases by a lot, and producer surplus will reduce at the ceiling price.
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This can cause layoffs as producers will want to maintain profits, unless otherwise instructed[ in case of apprise from government], in which case they may resort to reducing wages.
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Deadweight loss is more problematic for goods with inelastic PED as profit loss is certain unless; as stated government is ready to subsidise/ buy the shortage.
Evaluation
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Some consumers will benefit if they are able to purchase the good, as prices are lower, this can also counteract periods of production where demand increases drastically; Masks in case of a pandemic.
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However most consumers will not be able to purchase the good, which can lead to black markets. Producers also lose due to ;lower surplus. Governments may have to incur losses as they will be obliged to supply the shortage amount, for necessity markets; like masks during covid. Or else there will be market failure present.
Price Floor
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A legal minimum price for the sale of goods, these will only be effective if set above the current equilibrium price. These are used to prevent exploitation of producers[ too low profits] or to reduce market failure[ due to demerit goods] and can be implemented for long term or short terms depending on the problem..
Price Floors
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Yet again there is disequilibrium in market due to the price control, if government does step in for a second time.
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However it is very often that governments make sure to the producer that they will purchase the supply surplus or impose restrictions to limit supply. The surplus bought might be exported or stored.
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Producer surpluses increases dramatically and consumer surplus decreases.
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National minimum wage legislation can also be considered a price floor as prices are increased above equilibrium, and these are legal minimums that producers must abide.
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The diagram for labour markets with NMW legislation can be used interchangeably with the prior diagram for floor price.
Evaluation
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Very good for producers in agricultural markets as prices are often too low for costs. Helps reduce negative externalities due to demerit goods.
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For NMW, this can reduce unemployment as it incentivises people who may have been unemployed to start working and can make current workers more effective.
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Can be costly for the government if they buy the surplus. If producers are to limit production this can cause layoffs. The producers may become dependant on the government to buy their produce.
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For NMW, this can cause unemployment if firms cant increase wages for all workers because it would raise costs too much.
2.7.4 Direct Provision, Regulation & Nudges
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One type of market failure is the lack of public goods, which can be directly provided by the government.
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This is a market failure as public goods are non excludable and non rival meaning people who haven’t paid for the good can also utilise it. Which isn't the best for firms profits[no possibility to make profit from the ‘free riders’], like streetlights.[ Although these will be paid for by the taxpayers ] and can cause the usage of non price rationing due to high demand; as goods will be mostly free of charge.
Legislations and regulations
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The creation and enforcement of law to limit market failure and negative externalities.
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Rule breakers can be imprisoned or fined which can generate government revenue which can be used to provide for the economy.
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Enforcement will require more employment by the government and still may prove difficult to do due to the complexity of controlling an economy. It can also cause illegal markets which would produce even more negative externalities than before.
Consumer nudges
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Methods to influence consumer decisions without the use of regulations; so it maintains freedom of choice and responsible behaviour within its citizens
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Naturally this will be based on behavioral economics as we touched on in the unit 2.4
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This can be providing information useful for the consumer to finalise on a decision[food labels], default options or pre selected options that people tend to stick to[Opt out systems] Framing of products to highlight the consequences or benefits[ Cigarettes packs often have graphic pictures of cancer patients ] Incentives/Disincentives can be provided[ Indian Government provides benefits to owners of electric vehicles ] Social Norms to promote responsible actions. Governments can also send feedback and reminders to encourage responsible behaviour.
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However it isn't guaranteed to work, and there are many ethical concerns linked to the potential lack of transparency. Citizens may also purposefully go against these nudges.