Yukihiro Murakami
Economics – Government Intervention
SL/HL Core – Assessment Objectives
Sub-topic
Indirect taxes
Specific (fixed amount) taxes and ad
valorem (percentage) taxes and their
impact on markets
AO2 - Explain why governments impose indirect (excise) taxes.
Governments impose indirect taxes to gain revenue from a good/service.
The tax is usually imposed on goods with inelastic demands so that
most of the tax burden is on the consumer.
AO2 - Distinguish between specific and ad valorem taxes.
Specific tax is a tax which has a fixed value for all quantity supplied. On
the contrary, ad valorem taxes are percentage taxes that are imposed for
every quantity supplied.
AO4 - Draw diagrams to show specific and ad valorem taxes, and
analyse their impacts on market outcomes.
See below.
The supply curve with specific tax shifts up/left and is parallel to the
original supply curve. With a specific tax, downsizing in companies will
occur, as well as increased prices for the consumers. The government
will gain revenue.
The supply curve with ad valorem taxes creates a steeper sloped supply
curve compared to the original curve. With an Ad Valorem price, the
same effect of specific tax will take place.
AO3 - Discuss the consequences of imposing an indirect tax on
the
stakeholders in a market, including consumers, producers and the
government.
Tax incidence and price elasticity of
demand and supply
Consumers: Higher price of the products overall, if the demand for the
product is inelastic the price is higher; if the demand for the product is
elastic the price is lower than that of the price of the product when its
demand is inelastic.
Producers: Overall, imposing the tax will decrease total quantity
supplied because of increased price on supplies. Furthermore,
unemployment rates may rise as less supply would be needed.
Government: The government will gain revenue by imposing an
indirect tax.
AO2 - Explain, using diagrams, how the incidence of indirect
taxes
on consumers and firms differs, depending on the price elasticity of
demand and on the price elasticity of supply.
See below.
 If PED is elastic, producers pay for most of the tax.
 If PED is unit elastic, producers and consumers both pay
the same amount of tax.
 If PED is inelastic, consumers pay for most of the tax.
AO4 - Plot demand and supply curves for a product from linear
functions and then illustrate and/or calculate the effects of the
imposition of a specific tax on the market
(on price, quantity,
consumer expenditure, producer
revenue, government revenue,
consumer surplus and producer surplus).
See below
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Subsidies
Impact on markets
AO2 - Explain why governments provide subsidies, and describe
examples of subsidies.
Governments provide subsidies in hopes to increase the consumption of
a certain good by lowering its prices, to guarantee the supply of
products that the government thinks are necessary for the economy, and
to enable producers to compete with overseas trade.
AO4 - Draw a diagram to show a subsidy, and analyze the impacts
of a subsidy on market outcomes.
A graph with subsidy shifts the supply curve to the right, helping
producers produce more at every price. Subsidy would increase the total
supply quantity and would lower the price for consumers and suppliers.
However, in this case, the government loses money by funding
companies/firms. There is an opportunity cost: they could be using the
money on something else such as infrastructure. This would also give an
unfair advantage to firms receiving subsidies when compared to
companies over seas.
AO3 - Discuss the consequences
of providing a subsidy on
the
stakeholders in a market, including consumers, producers and the
government.
Consumers: They would be able to consume products at a lower price.
Producers: They would be able to produce products at a lower price.
Government: They would have to fund money towards
companies/firms which have an opportunity cost for doing something
else.
Producers in other countries: Producers in other countries would be
harmed if they are not receiving the same amount of subsidy as the d
AO4 - Plot demand and supply curves for a product from linear
functions and then illustrate and/or calculate
the effects of the
provision
of a subsidy on the market (on price, quantity, consumer
expenditure, producer revenue, government expenditure, consumer
surplus and producer surplus).
Price controls
Price ceilings (maximum prices):
rationale, consequences and examples
AO2 - Explain why governments impose price ceilings, and describe
examples of price ceilings, including food price controls and rent
controls.
To protect consumers to ensure low-cost food for the poor.
Food price controls – Lowering price of food because they are a
necessity good, to ensure that the poor are getting the food.
Rent controls – Lowering price of rents because they are a necessity
good, to ensure that the poor have shelter.
AO4 - Draw a diagram to show a price ceiling, and analyse the
impacts of a price ceiling on market outcomes.
With a price ceiling, quantity demanded would increase as quantity
supplied decreases creating excess demand. Also, the price would
increase to maximum price or higher.
AO3 - Examine the possible consequences of a price ceiling,
including shortages, inefficient resource allocation, welfare impacts,
underground parallel markets and non-price rationing mechanisms.
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With a price ceiling, there would be excess demand, and thus black
markets could arise. The sellers in the black market would take
advantage of the excess demand and sell the products at a higher price
than the price ceiling.
AO3 - Discuss the consequences
of imposing a price ceiling
on the
stakeholders in a market, including consumers, producers and the
Government.
Consumers: Price would decrease, thus it will help poor consumers
consume (necessity) goods.
Producers: There would be fewer incentives to produce because of
decreased price. Unemployment is possible.
Governments: To resolve the excess demand, they would have to:
1. Offer subsidies
2. Produce the product themselves
3. Release stocks of the products (If possible)
AO4 - Calculate possible effects from the price ceiling diagram,
including the resulting shortage and the change in consumer
expenditure (which is equal to the change in firm revenue).
Price floors (minimum prices):
rationale, consequences and examples
AO2 - Explain why governments impose price floors, and describe
examples of price floors, including price support for agricultural
products and minimum wages.
Governments impose price floors to raise incomes for producers of
goods and services that the government thinks are
important(agriculture), and also to protect workers by setting
minimum wage.
AO4 - Draw a diagram of a price floor, and analyse the impacts of a
price floor on market outcomes.
With a price floor, quantity supplied would increase while quantity
demanded decreases, creating an excess supply. Price would be lower at
minimum price or higher.
AO3 - Examine the possible consequences of a price
floor,
including surpluses
and government measures
to dispose of the
surpluses, inefficient resource allocation and welfare impacts.
With the imposition of price floor, governments would have to buy up
any surplus products to keep firms going(which has an opportunity
cost). The governments then would store, destroy, or sell the products.
A black market could arise selling products at a lower price than the
minimum price.
AO3 - Discuss the consequences
of imposing a price floor
on the
stakeholders in a market, including consumers, producers and the
government.
Consumers: Higher price, Less quantity demanded
Producers: More incentives to produce products, Raised incomes,
minimum wage set.
Governments: Must buy any abundant supply so that firms don't stop
producing, which has an opportunity cost.
AO4 - Calculate possible effects from the price floor diagram,
Yukihiro Murakami
including the resulting surplus, the change in consumer
expenditure, the change in producer revenue, and government
expenditure to purchase the surplus.
Yukihiro Murakami
Yukihiro Murakami
PeXQe0 : Initial consumer expenditure at equilibrium.
P1YQ10 : Consumer expenditure after minimum price is imposed.
PeXQe0 : Initial producer revenue at equilibrium.
PminZQ20 : Producer revenue after minimum price is imposed.