Government Intervention – Pink line class
1.3
Taxes – (on separate word document)
Subsidies
Price floors
Price ceilings
1.3 Government Intervention:
Subsidies
Government Intervention (Subsidies)
A subsidy is effectively an opposite tax. Governments
place subsidies to encourage the production or
consumption of goods, in result, gaining a greater
quantity demanded.
Subsidies are usually given in the form of cash payment
(most commonly attained through taxation of other
areas) or a tax reduction.
Government Intervention (Subsidies)
Why governments give out subsidies:
 Supports a desirable activity (eg; exports)
 Essentially reduces costs of production
 Keeps prices of staples/necessities low
 Maintains employment levels by increasing revenues of
producers
 Raises availability for a greater portion of the population
 Improve allocation of resources
Government Intervention (Subsidies)
The Consequences of Subsidies in the Market (Who
benefits?):
Consumers: Consumers benefit from the fall in price of the good
Producers:
Producers benefit as firm revenues increase because
#cashmoney from the #abbott
Government: Governments are negatively impacted as they pay the subsidy,
which is a burden on their budget
Workers:
Workers benefit as supply increases, firms hire more workers to
tackle the new output
Foreign
producers:
Domestic producers benefit as the lowered prices increase
exports, but foreign producers may not be able to compete with
the subsidised prices. They are negatively affected
Society as a Society as a whole is WORSE OFF as there is an over
allocation of resources to the production of that particular good.
whole:
Government Intervention (Subsidies)
Example of subsidies: Solar panels, vaccinations,
childcare, public transport.
Government Intervention (Subsidies)
There are several types of subsidies, some of these
include…
 Grants and other direct payments
 Tax concessions
 In-kind subsidies
 Cross subsidies
 Credit subsidies and government guarantees
 Direct aid
Government Intervention (Subsidies)
• Producer Subsidy
causes firm’s
supply curve to
shift to the right.
http://beta.tutor2u.net/economics/reference/governmentintervention-producer-subsidies
•
A direct subsidy TO THE CONSUMER
has the effect on increasing demand
shift of demand curve to the right.
Government Intervention (Subsidies)
So…
 It shifts supply curve to the right
 There is more supplied at each price
 Decrease on the market equilibrium price
 Increase in quantity demanded
Government Intervention (Subsidies)
http://beta.tutor2u.net/economics/reference/governmentintervention-producer-subsidies
Government Intervention (Subsidies)
• In an economy where resources are allocated
efficiently, a subsidy introduces allocative
inefficiency and welfare losses
• In an economy where resources are allocated
inefficiently (due to market imperfections), then a
subsidy can improve the allocation of resources if it
is designed to correct the source of the inefficiency.
1.3 Government Intervention
Price Floors
Price Controls- Price Floors
• Price controls- cases where for some reason the government considers
the market-determined (equilibrium) price unsatisfactory and, as a result,
intervenes and sets the price either below or above it
• Price floor- price set above
• Designed to protect producers
• Examples: agriculture, minimum wage
Equilibrium
Demand
Schedule
P Qd
P
S
$5
P Qs
4
$5 10
$5 50
Equilibrium Price = $3
(Qd=Qs)
$4 40
3
$4 20
$3 30
$2 50
$1 80
Supply
Schedule
2
$3 30
1
o 10
D
20
30
40
50
60
70
Equilibrium Quantity is 30
80
Q
$2 20
$1 10
14
Price Floor
Demand
Schedule
P Qd
P
Supply
Schedule
S
$5
Price Floor
4
$5 10
P Qs
$5 50
3
$4 20
$3 30
$2 50
$1 80
$4 40
2
$3 30
1
o 10
D
20
30
40
50
60
70
80
Q
$2 20
$1 10
15
Impact on Market Outcomes- Surplus
Demand
Schedule
P Qd
P
$5
Supply
Schedule
S
Surplus
Price Floor
4
$5 10
P Qs
$5 50
3
$4 20
$3 30
$2 50
$1 80
$4 40
2
$3 30
1
o 10
D
20
30
40
50
60
70
80
Q
$2 20
$1 10
16
Government must purchase the surplus, otherwise the price collapses
Consumer and Producer Surplus
With Price Floor
P
Without Price Floor
P
S
$5
Consumer
surplus 4
$5
4
Producer
surplus
3
2
S
3
2
D
D
1
o 10
1
20
30
40
50
60
Q
o 10
20
30
40
50
60
Q
Consumer and Producer Surplus- Elastic Demand
With Price Floor
P
4
S
Consumer
surplus
3
D
$5
Producer
surplus
2
1
o 10
Without Price Floor
P
S
$5
4
D
3
2
1
20
30
40
50
60
Q
o 10
20
30
40
50
60
Q
Impact on Market Stakeholders
Consumers
• Enjoy less of the product at a higher price per unit
Producers
• Sell more at a higher price leading to increased revenues
• May be less cost conscious leading to inefficiency and wasting resources
Government
• Government expenditures increase because they are forced to buy the
surplus and store it, destroy it or sell/donate it abroad
• Taxes may eventually increase due to government spending
Examples of Price Floors- Agricultural Markets
• Protect the agricultural sector
• Encourage existing producers to increase their levels of production and
attract new firms to enter the market for certain agricultural goods
• In the EU large stockpiles were created and purchased and stored by the
EU
• Over-production was dealt with by paying farmers to leave fields fallow
(paying farmers not to produce) as well as introducing quotas
Examples of Price Floors- Minimum Wage
• Normally, wages are determined by supply and demand in the labor
market
• In sectors where the equilibrium price determined by supply and demand
of labor is below the minimum wage, the level of the minimum wage acts
as a price floor and the effect is to artificially raise the price of labor
• Increase the supply of labour but reduce demand for labour
• Supply increase, demand decreases
• A minimum wage policy will benefit some workers, it will also typically
create unemployment
Bibliography
Books
Ziogas, C, 2008. Economics for the IB diploma- Study guide. 2nd ed. Oxford: Oxford University Press.
Websites
Econport. 2015. Price Controls. [ONLINE] Available at:
http://www.econport.org/content/handbook/Equilibrium/Price-Controls.html. [Accessed 03 May 2015].
Hann P. 2015.Examples of Current Price Floors and Ceilings in Today's Economy. [ONLINE] Available
at: http://www.brighthub.com/office/finance/articles/123133.aspx. [Accessed 03 May 2015].
Price Floors - Economics. 2015. Price Floors - Economics. [ONLINE] Available
at: http://economics.fundamentalfinance.com/micro_price-floor.php. [Accessed 03 May 2015].
Videos
Hingston A. (2010). Price floors and surplus. [Online Video]. Available from:
https://www.youtube.com/watch?v=zjXwvQz7f2o. [Accessed: 29 March 2015].
Khan Academy. (2009). Minimum wage and price floors | Deadweight loss. [Online Video]. Available
from: https://www.khanacademy.org/economics-finance-domain/microeconomics/consumer-producersurplus/deadweight-loss-tutorial/v/minimum-wage-and-price-floors. [Accessed: 29 March 2015].
Jakka, Han, Nick, Jiwon, Mengfei
Group 3
Price Ceilings
What is a price ceiling?
A government-imposed price control or
limit on how high a price is charged for
a product.
Explain why governments impose price ceilings, and
describe examples of price ceilings, including food
price controls and rent controls.
Example 1. Rent control in New
York City
To protect low income
Rent control is a price ceiling
on rent.
individuals from not
being able to afford
important resources.
Example 2. Food price controls
Food price control: by setting a
price ceiling on food means
that producers aren’t able to
charge more for certain
essential goods.
Impacts on market
outcomes
Draw a diagram to
show a price
ceiling, and
analyse the
impacts of a price
ceiling on market
outcomes.
Price ceiling (maximum price) and
market outcomes
Through imposing a price that is lower than the equilibrium price, a
price ceiling results in a lower quantity supplied and sold than at
the equilibrium price. This is displayed in the diagram above,
where the price ceiling, Pc, corresponds to quantity Qs that firms
supply, which is less than the equilibrium quantity Qe that
suppliers would supply at Pe.
Furthermore, the price ceiling, Pc, gives rise to a greater quantity
demanded than at the equilibrium price: the quantity consumers
want to purchase at price Pc is given by Qd, which is larger than
quantity Qe that they would purchase at price Pe.
A price ceiling does not allow the market to clear; it creates a state of
disequilibrium where there is a shortage (excess demand).
Definition of ‘consumer expenditure’: The amount of money spent by
households in an economy. The spending includes durables, such as washing
machines, and nondurables, such as food. It is also known as consumption,
and is measured monthly. The change in consumer expenditure is equal to the
change in firm revenue, which is the amount of money that a company actually
receives during a specific period, including discounts and deductions for
returned merchandise.
Consequences for the economy
Examine the possible consequences of a price ceiling,
including shortages, inefficient resource allocation,
welfare impacts, underground parallel markets and nonprice rationing mechanisms.
Shortage
If a price ceiling has been set, the product can only be sold at a maximum price, which is
often below the equilibrium selling price. This causes a shortage for the product as at a
lower price, the quantity demanded by consumers is more than the quantity the
producers are willing to sell. This is due to the law of demand and supply.
Inefficient resource allocations
Resources are often wasted due to a price ceiling, these resources are the time, effort and
money consumers spend in order to deal with the shortages created by the price
ceiling. These resources are wasted as people will need to spend more time and effort
to find the goods they want while they could be using the resources to do something
else.
Welfare Impacts
Producer surplus is the amount that producers benefit by selling at a market price that is
higher than the least they would be willing to sell for. Consumer surplus is the
monetary gain obtained by consumers because they are able to purchase a product for
a price that is less than the highest that they are willing to pay.
Deadweight loss
A deadweight loss is a loss of economic efficiency that can occur when equilibrium for a good or service is not
achieved or is not achievable.
When a price ceiling is set, a shortage occurs. For the price that the ceiling is set at, there is more demand than
there is at the equilibrium price. There is also less supply than there is at the equilibrium price, thus there is
more quantity demanded than quantity supplied. An inefficiency occurs since at the price ceiling quantity
supplied the marginal benefit exceeds the marginal cost. This inefficiency is equal to the deadweight welfare
loss.
Underground Parallel Markets
Underground Parallel Markets = Black Market
People sell consumers as much of a controlled good as they want, but at a price higher than the price ceiling.
(Generally illegally). These markets provide higher profits for producers and for consumers that people take
the risk of fines or imprisonment.
Non-Price Rationing Mechanisms
If a price ceiling is compulsory for a long time, the government may need to ration the good to ensure availability
for the greatest consumers. One way is by issuing tickets to consumers. Therefore, government is only allowed
to put out as much good in the marketplace as there are the amount of available tickets. Obtaining goods
would therefore require the consumer to present the ticket when purchasing. This can minimize the impact of
shortage caused by price ceiling, but is usually reserved for times of war or severe economic distress.
Discuss the consequences of imposing a price ceiling on
the stakeholders in a market, including consumers,
producers and the government.
Price ceiling is defined as “a situation where the government sets a maximum
price, below the equilibrium price to prevent producers from raising the
price above it” (ibguides.com, 2012).
• Government:
• No real consequences.
• Consumers:
• Shortage
• But cheaper
• Producers:
• Profit