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Lecture Outline - 8 - Govt Intervention

The document discusses various reasons for and methods of government intervention in markets. It outlines three main reasons for policy intervention: to correct market failures, achieve equitable income distribution, and improve economic performance. Some key forms of intervention discussed include legislation, regulation, direct provision of services, fiscal policy like taxes and subsidies, and price controls. The effects of taxes, subsidies, and price floors/ceilings on markets are explored. Government intervention can distort resource allocation and encourage inefficiency, but may be necessary to address issues like inequitable prices.

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Dhanushka Rajapaksha
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38 views4 pages

Lecture Outline - 8 - Govt Intervention

The document discusses various reasons for and methods of government intervention in markets. It outlines three main reasons for policy intervention: to correct market failures, achieve equitable income distribution, and improve economic performance. Some key forms of intervention discussed include legislation, regulation, direct provision of services, fiscal policy like taxes and subsidies, and price controls. The effects of taxes, subsidies, and price floors/ceilings on markets are explored. Government intervention can distort resource allocation and encourage inefficiency, but may be necessary to address issues like inequitable prices.

Uploaded by

Dhanushka Rajapaksha
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Lectureoutline8GovernmentInterventioninthemarket

Weexaminedthebehaviorofthemarketintheabsenceofthegovernmentintervention

Themainreasonsforpolicyinterventionare:
Tocorrectformarketfailure
Toachieveamoreequitabledistributionofincomeandwealth
Toimprovetheperformanceoftheeconomy
Source:
GovernmentLegislationandRegulation
Parliament can pass laws that for exampleprohibitthe sale of cigarettes to children, or ban
smokingintheworkplace.Thelawsofcompetitionpolicy
imposeprice controlsin most of the main utilities such as telecommunications, electricity, gas
andrailtransport.
DirectStateProvisionofGoodsandServices
FiscalPolicyIntervention
(a) Indirecttaxes
(b)Subsidiestoconsumers
(c)Taxrelief:Thegovernmentmayofferfinancialassistancesuchastaxcreditsforbusiness
investmentinresearchanddevelopment
(d)Areductionincorporationtax(ataxoncompanyprofits)designedtopromotenewcapital
investmentandextraemployment

1. InafreemarketsystemgovernmenttakespartinproducingonlyPublicGoods
Publicgoods:SomeonesConsumptionwillnotdeprivesomeoneelsesconsumption.
Privategood:SomeonesConsumptionwilldeprivesomeoneelsesconsumption.

2. Inamixedeconomicsystemgovernmentinterferesintheeconomyin:
a. participatinginproduction
b. Generatinggovernmentrevenuethroughimposingdirectandindirecttaxes.
c. Providingsubsidiestoconsumersandproducers
d. Protectingproducersandconsumersimposingpriceceilings
Free
Market
System
Govt.
Market
System
Govt.
Effectsofdirecttaxonthemarketisminimal
Effectsofindirecttaxonthemarketaresubstantialdependingupontheelasticityofdemandand
supply.
CaseofInelasticdemandfortheproduct:
Pricewillgoupequivalenttotaxrate













ConsumersurplusandProducersurplus

Consumersurplusorconsumers'surplusisthemonetarygainobtainedbyconsumers
becausetheyareabletopurchaseaproductforapricethatislessthanthehighestprice
thattheywouldbewillingtopay.Producersurplusorproducers'surplusistheamount
P
0

S0
S2
P0
S
D S1
P1
t
t
D
P0
S
D
S1
P1
t
P0
S
D
S1
P1
t
thatproducersbenefitbysellingatamarketpricethatishigherthantheleastthatthey
wouldbewillingtosellfor.

Asubsidyisapaymentbythegovernmenttosuppliersthatreducetheircostsofproductionand
encouragesthemtoincreaseoutput.Theeffectofagovernmentsubsidyistoincreasesupplyand
(ceterisparibus)reducethemarketequilibriumprice.Thesubsidycausesthefirm'ssupplycurveto
shifttotheright.Theamountspentonthesubsidyisequaltothesubsidyperunitmultipliedbytotal
output.Occasionallythegovernmentcanofferadirectsubsidytotheconsumerwhichhastheeffect
ofboostingdemandinamarket.
Demandelasticityandproducersubsidy

Governmentinterventionleadstoworsendistributionofresources.
1. Distortion of the Market:Subsidies distort market prices this can lead to a misallocation of
resourcesmanyeconomistsbelievethatthefreemarketmechanismworksbest.
2. FinancialCost:Subsidiescanbecomeexpensivenotetheopportunitycost!
3. Whopaysandwhobenefits?:Thefinalcostofasubsidyusuallyfallsonconsumers(taxpayers)
whothemselvesmayhavederivednobenefitfromthesubsidy
4. Encouraging inefficiency:Subsidy can artificially protect inefficient firms who need to
restructurei.e.itdelaysmuchneededeconomicreforms
5. RiskofFraud:Everpresentriskoffraudwhenallocatingsubsidypayments
P0
S1
D
S
P1
S
P1
S1
D
S
P0
s
6. There are alternatives:It may be possible to achieve the objectives of subsidies by alternative
meanswhichhavelessdistortingeffects,forexamplebydirectincomesupportthroughthetax
andbenefitsystem

Priceceilings

Whenmarketpriceistoohighandwhenitaffectsthemajorityofpeopleinthesystemthe
governmentintervenesandsetaceilingprice.
Gasolineprices,milkfoodpricesmedicaldrugsetc.
Itleadstocreatequeues.Ifthereisaqueuedisciplinethenfirstcomefirstservesystemworks.
Thisalsoleadstoblackmarkets.BlackmarketpricewillretainatP2.
Pricefloor
Becauseofthissenseofinequity,orbecauseofpoliticalpressurefromfarmgroups,thegovernment
hashadprogramstoaidfarmerssincethemid1930s.Oneofthese,calledthepricesupport
program,isanexampleofapricefloor.Thisisthefarmersproblem.

Minimumwages.
P0
D1
S
PriceFloorP1
D
Wm
S
PriceFloorW1
D
P1
D
S
P0
P2
CeilingPrice

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