Policy 1 – Subsidies
A subsidy means the government gives
funding to organizations. This in turn
lowers the costs of production so that
producers in the market are willing and
able to supply more. The diagram
illustrates this with supply shifting to the
right. Governments often do this to
increase the supply of merit goods such as
renewable energy or education.
Subsidies have an opportunity cost as the government is using tax money that
could be used on other things. However, if all are able to consume merit goods
most governments will accept that resources have been allocated in the best way.
Policy 2 – Excise Taxes
Governments can set taxes on specific goods,
many of which are demerit goods such as
cigarettes or alcohol. This will add to costs and
discourage their production and consumption.
The producer of the product is responsible to
pay the tax directly to the government,
meaning they will earn less profit. As a result,
many firms will reduce production. Firms may
also increase the price of the good to recoup
lost profits. The increase in price is likely to
decrease the quantity that consumer purchase.
The diagram illustrates this with supply
shifting to the left.
One potential downside of these types of taxes is that people might keep buying
demerit goods anyway, especially addictive goods like cigarettes. With the tax, those
people will be even worse off due to increased spending.
Policy 3 – Price Ceiling
The government may feel the price of a good
is too high because the good is a necessity or
a merit good. In response, governments
could set a maximum price for the good
called a price ceiling. The diagram illustrates
this with P2 representing the maximum price
allowed by the government. This increases
quantity demanded to Q3 and decrease
quantity supplied to Q2. Note that this
maximum price must be below the market
price to be effective.
Price ceilings can cause unintended problems. Maximum prices decrease supply and
increase demand, causing a shortage. Shortages like this may cause ‘black markets’ to
emerge that illegally supply the good at a higher price for those affected by the shortage.
Policy 4 – Government Stockpiles
Governments may plan ahead for
emergencies by stockpiling necessities such
as food that can be distributed in the form
of government rations in times of famine. In
response to the covid-19 pandemic, some
governments also began stockpiling medical
devices such as ventilators. By providing
these goods directly, the government can
increase supply, as shown in the diagram.
One downside of this approach is that governments don’t always know what
goods will be needed in the future or how much of the good they will need.
Distribution also poses difficulties, as during emergencies it could be difficult to
transport goods and ensure that goods are rationed efficiently.