4.

Why do governments intervene in the markets? FETCH PM

Earn tax revenue for Indirect taxes On inelastic goods like

government
Provide support to firms
Provide support to low income
households
Influence level of production
Influence level of consumption
Correct market failure
Equity
Subsidies, price floors
Subsidies, price ceilings
Direct provision of services
Indirect taxes
Indirect taxes, nudges,
commands and controls
Indirect taxes
Subsidies
price floors
price ceilings
nudges
commands and controls
direct provision of services
cigarettes, petrol, alcohol
To help new companies
compete with larger firms
To help companies that
produce environment friendly
goods - solar power
Free education, free
healthcare, unemployment
benefits
Sugar taxes Reduces
production – sugary drinks
Demerit goods - Smoking ban
in public areas
Merit goods – compulsory
education
 Definitions

Price control
Price ceiling
Shortage
Rationing
Underground markets
Allocative efficiency
Overallocation
Consumer surplus
Producer surplus
Community surplus
Welfare loss
Market Equilibrium
Market disequilibrium
Price floor
Surplus
Underallocation
Indirect Tax
Specific tax
Ad valorem tax
Sales tax / VAT
Excise tax
Subsidy
 Price ceiling Price floor
Define
Purpose
Below equilibrium price Above Equilibrium price

Quantity demanded > Quantity supplied = Shortage Quantity demanded < Quantity supplied = Surplus
Causes market disequilibrium Causes market disequilibrium
Consequences for Markets Consequences for Markets
1. Shortages 1. Surplus + govt disposing surplus
2. Non-price rationing 2. Firm inefficiency
3. Underground markets 3. Overallocqation
4. Underallocation 4. Welfare loss
5. Welfare loss

Consequences for stakeholders: Consequences for stakeholders:

1. Consumers 1. Consumers
2. Producers 2. Producers
3. Workers 3. Workers
4. Government Government
Example – rent control, food price control Example –
Rent controls are regulations that allow only a gradual In the labour market, a national minimum wage (NMW) set
increase in rent, if at all, compared with what the above the market equilibrium wage rate, ensures all
free market may demand in order to protect tenants. workers have enough income to provide for their basic
Without rent controls, the high demand for housing in cities needs. Employers can pay more than the minimum amount,
could cause rent prices to increase but they cannot pay less. In this case, the suppliers are
substantially in an unsustainable manner thereby displacing employees (who supply their labour services) and
tenants and their families. employers are the consumers (who demand labour for their
Consumers who can access the good or service at the lower services in the production process).
price can benefit from the imposition of the price ceiling. In Figure 10.12, the NMW being higher than the market
However, price ceilings distort market forces and therefore equilibrium wage rate (where DL = SL) causes the supply of
can result in an inefficient allocation of scarce resources, labour (SL) to be greater than the demand for labour (DL).
such as a lack of housing. This creates a deadweight loss In theory, the NMW results in excess supply of labour. In
other words, the higher costs of labour causes
In Figure 10.7, consumer surplus was originally area A + B, unemployment, at least in the short run, ceteris paribus.
and producer surplus was area C + D + E. The imposition of
the maximum price of P2 reduces the quantity supplied to
S1, thereby creating a shortage. This changes consumer
surplus to area A + C and reduces producer surplus to area
E, so there is a deadweight (welfare) loss as shown by the
shaded area. In other words, a drawback of binding price
ceilings is a decrease in total community surplus (the sum of
consumer and producer surplus).

Owing to the shortage created, maximum prices can also

cause underground parallel markets to appear. In Figure
10.7, traders in parallel markets will charge will charge a
higher price than P2 thereby eliminating
the excess demand. Such markets are generally illegal.
In Figure 10.13, the price
floor reduces the quantity demanded to D1 (as consumers
need to pay higher prices), creating a surplus (excess
supply). This reduces both consumer and producer surplus
as shown by the shaded area, so there is a decrease in
social surplus. In other words, there is a deadweight loss to
society.
Indirect tax subsidy