2023 T3 Govt Intervention - STUDENT
2023 T3 Govt Intervention - STUDENT
2023 T3 Govt Intervention - STUDENT
• Consumption by one person results in the good not being available for consumption by another.
Private
good • Examples: laptop, clothing, motor vehicles, book, lightbulb.
• Private goods are produced by private firms & government.
Non-rivalry o Consumption of the good by one person does not reduce the amount
(non- available for consumption by another person.
diminishability or
non- o Example: when one person has walked along the street, it does not
exhaustibility): mean that there is less street lighting left for later walkers.
o Those who cannot pay cannot be prevented from using the good.
Once a public good is provided, everyone can use it.
Public Non-
good excludability: o Example: Once the streetlight is provided for, anyone who walks along
the street at night benefits from the lighting. No one, including non-
payers, can be excluded from benefitting or consuming the
streetlight.
Examples:
streetlights,
national • Public goods are produced by the government:
defence;
o Due to non-excludability feature, it is not possible to prevent non-payers from receiving the
police;
benefits of the public good once it has been provided. This is known as the free rider problem.
lighthouse.
o The non-excludability feature & free rider problem remove the opportunity for private firms
to earn a profit from producing public good, giving private firms no incentive to produce them.
• If the park is visited by only a few people at the start • Although it is often difficult to exclude non-paying
of the day, these few would be able to enjoy the consumers, but quasi-public goods can be made
benefits themselves. Even as more people arrive to excludable.
enjoy the benefits, their arrival does very little to
diminish enjoyment of that park. • For example:
o fencing the park and charging an entrance fee.
• However, there will come a point where the park o building toll booths to charge for road usage.
becomes crowded and space becomes limited; other
people’s conversations and music become more
audible. Enjoyment thus is reduced. • Although quasi-public goods can be made excludable,
private firms would still be reluctant to provide them.
This is because the money collected may not cover the
cost of building and maintenance of the road or the
park.
Examples of merit goods: education and healthcare. Examples of demerit goods: cigarettes (tobacco), alcohol,
drugs.
Another reason for underconsumption of merit goods is low income. Consumers may recognise the benefits of merit
goods but lack the income to be able to afford the merit good in the quantities they would like.
• Market failure refers to the failure of the market to allocate resources efficiently.
• Market failure results in allocative inefficiency, that is, either too much or too little of the goods and services are produced and
consumed.
o information failure
o price fluctuations
• Reason: The wage earned depends on the ability of the individual or upon the value of the
resources owned. Hence, different incomes are simply a reflection of differences in skills,
experiences and qualifications.
• Although not regarded as a market failure, governments are of the view that unequal
income distribution is undesirable or unacceptable. A person’s income may be so low that
he or she is unable to afford basic necessities. Therefore, governments implement policies
to reduce income inequality.
• Income (and wealth) inequality will be covered later in this chapter (page 12 onwards).
• Maximum price is a price set below equilibrium price. The aim is to prevent the price of a particular good from rising to an
unacceptably high level.
• Maximum price is usually imposed on necessities – food items; transport; utilities such as water, gas and electricity.
• Shortage will exist. In the diagram above, at the maximum price of Pmax, there is a shortage of QD – QS.
• To overcome the shortage problem created by the maximum price policy, government may consider:
o subsidising producers to induce a rise in supply of the good.
o directly producing the good.
o rationing the good.
• Government imposes maximum level of rent that landlords are allowed to charge their tenants. The purpose is to protect
low-income households from being exploited by landlords.
• There will be a shortage of accommodation available. In the diagram above, there is a shortage of QD – QS accommodation.
Landlords become reluctant to supply rental accommodation, while quantity demanded for accommodation has increased to
QD.
• Minimum price is a price set above equilibrium price. The aim is to help raise the incomes of producers, particularly in
agriculture.
1. Producers may lack incentive to be cost efficient since they are able to legally sell the good above the market price. Consumers
are worse off as they would have to pay a higher price.
2. There is a surplus of QsQd. At the minimum price, quantity supplied has increased to Qs, while quantity demanded has fallen
to Qd. Inefficient allocation of resources occurs, that is, too many resources are allocated to the production of the good.
Due to the surplus, producers may be forced to sell the good below the minimum price. Minimum price thus becomes
ineffective.
AS Level: Topic 3 Notes compiled by | Cherilyn Low (August 2023) 6
TO OVERCOME THE SURPLUS PROBLEM:
a) Government may purchase the excess supply of the good. However, this will then pose another problem, i.e. what does
the government then do with the excess that they have purchased. In addition, taxpayers may be affected as they may
have to pay higher taxes in order for the government to purchase the excess supply at the higher price of Pmin.
b) Government may restrict production of the good. Example: Government can either force or pay farmers to reduce the
size of their crops or leave part of the land uncultivated. This will shift the supply curve to the left.
Minimum price policy can also be used to discourage the consumption of demerit goods (alcohol, cigarettes). Producers
of demerit goods are required by law to sell the goods at a price that is higher than the current market price. This makes
the demerit goods more expensive and discourages consumption.
P
S1 • Government views current market price of P1 as too low.
P2 • By implementing a minimum price of P2, quantity demanded
P1 for the demerit good will fall to Q2.
D1 EFFECTIVENESS:
0 Q
Q2 Q1 • Black market may develop where the demerit good is sold at a
price below the minimum price.
4. MINIMUM WAGE
Government sets a wage that is above the current market wage rate. The aim is to prevent exploitation of labour and to reduce
income inequality.
Wage
SL • Government views current market wage
Wmin rate WL as too low.
• Minimum wage increases the spending power of workers and raises their standard of living.
• Firms may be forced to lay off workers to reduce cost. This will cause unemployment to rise.
CONCLUSION: Impact of minimum wage on society is unclear. Some workers are better off since they receive a better wage.
Those who are unemployed are worse off.
• Buffer stock policy is a policy intended to stabilise prices (limit price fluctuations), especially in agriculture.
• Under this policy, price will be fixed at a particular level by the government.
o If there is excess supply at this price, the government will buy it up and store the surplus.
o If there is excess demand (shortage), government will sell (release) its stocks to the market.
If there is a bumper crop causing supply to rise to S2, there In the event of a bad harvest which causes supply to fall
is now excess supply (surplus) of Q2-Q1 at P1. to S3, there will now be a shortage of Q1-Q3 at P1.
• If government does not buy up the surplus, the price will • The shortage will cause the price to rise to P 3, which
fall to P2, which is below the government fixed price of is above the fixed price of P1.
P1.
• Therefore, government releases (sells) Q1-Q3 from
• Therefore, to keep the price at P1, government must the store onto the market. The shortage is
buy up the surplus of Q2-Q1. The surplus purchased by eliminated.
the government is then stored.
6. PROVISION OF INFORMATION
• In practice, there can be a problem of asymmetric information where one party (usually the seller) has access to more
information or better information than the other party (usually the buyer).
• Example: market for second hand cars. Some cars are ‘lemons’, constantly breaking down and requiring large repair bills. The
owner of the car for sale knows whether the car is a ‘lemon’ or not. If the owner of the car conceals this information, then the
buyer may end up purchasing the car.
• CHALLENGES with the above policies: people may reject the information. There is also long impact lag – consumers may be
more receptive towards the information only in the long-term (difficult to change mindset in the short-term).
7. REGULATION / LEGISLATION
1. Ban (Prohibition). Government prohibits consumption or production of demerit goods such as drugs. This makes
consumption or production of drugs like cocaine illegal. Government can introduce smoking ban in public places – schools,
restaurants, shopping malls, railway stations (this was enforced in the UK beginning July 2007).
2. Compulsory display of information. Example: requiring cigarette companies to display warnings and photographs on packets
of tobacco products to deter smoking; nutrition and allergy information on food packaging.
4. Lowering alcohol limit for drivers. This was implemented in Scotland in 2014.
5. Setting minimum age requirement for purchase of demerit goods such as alcohol and cigarettes.
7. Compulsory consumption and production. Government can force consumers to purchase merit good or force producers to
provide a merit good. Example: motorists are forced to buy car insurance by law; state-funded education is made compulsory
up to a certain age; safety belts in motor vehicles; smoke alarms in homes and offices.
The CHALLENGE with regulations / legislations is that there is high cost of enforcement / administration of laws. Regulations can
also be ignored.
AS Level: Topic 3 Notes compiled by | Cherilyn Low (August 2023) 9
8. TAX
• Tax can be used to discourage consumption and production of demerit goods. Government uses indirect tax such as excise
tax. The incidence of tax will fall on both firms and consumers thereby discouraging the production and consumption of
demerit goods.
** For explanation on the operation of tax, distribution of tax burden and the
relevant diagrams – refer to AS Topic 2 notes.
▪ tax is regressive in nature, thus having a greater impact on the poor compared to the rich.
▪ given that demand for demerit goods is inelastic, consumption is not effectively reduced. Most of the tax burden also
falls upon consumers.
9. SUBSIDY
• Subsidy is an amount of money paid by the government to a firm. Production costs are reduced leading to an increase in the
supply of the good. The price paid by consumers will also be lower.
** For explanation on the operation of subsidy and the relevant diagrams – refer
to AS Topic 2 notes.
5. Keep prices of essential services low. Example: public transport. Subsidising public transport would help lower income groups
who cannot afford private transport. It will also encourage more use of public transport thus reducing road congestion.
6. To guarantee the supply of products that the government thinks are necessary for the economy.
• Government directly produces public goods and merit goods to ensure sufficient quantities are available. This also ensures
that consumption will rise to the socially desirable level.
• Government can supply merit goods directly to consumers free of charge up to a certain extent. In the UK, primary school
education, visits to doctor and roads are provided in this way.
• Government can also provide essential goods and services. These typically include healthcare, education, sanitation and
water supply. This ensures that the poorer members of society have access to essential goods and services.
• Government may also delegate responsibility for provision of public and merit goods to local authorities, which in turn may
subcontract to private firms. In this case, government provides the good but does not produce it.
• INCOME is a flow of factor incomes that households receive such as wages from work; rent from ownership
of land; and interest and dividends from savings and ownership of shares. Income is a flow concept because
the earnings are variable over any given time period.
• WEALTH is the accumulation of assets such as property, ownership of land, company shares and bank
deposits. These are stocks as they are all quantities held at a given point in time. Wealth is a stock concept.
1. Lack of formal employment opportunities particularly for young people, but also those with professional skills.
2. Poor vocational training. As a result, industries cannot obtain the labour needed to maintain a viable operation in national and
international markets.
3. Lack of investment in education and health sectors. This could be due to low savings which holds back public sector
investment.
3.4.3 Measuring Inequality – the Lorenz Curve & the Gini Coefficient
5. In practice, the Lorenz Curve will hang below the 45° line. There is income inequality. Example: the poorest 55% earns 20% of
national income. Thus, the remaining 45% of households earn 80% of national income.
6. The further the curve drops below the 45° line, the greater will be the level of inequality.
7. If the Lorenz Curve moves inwards towards the 45° line, this means there is a lessening of inequality.
1. TAX
• Adam earns $38,000 per year. The total tax he paid was $10,200. Lily earns $90,000 per year.
The total tax she paid was $36,000. Calculate the average tax rate paid respectively by Adam
and Lily.
Your answer:
• In Year 1, Adam’s total income was $38,000. The total tax he paid was $10,200. In Year 2,
Adam’s total income increased to $48,000. The total tax he paid was $15,000. Calculate his
marginal tax rate.
Your answer:
Advantages: Advantages:
• Can be used as a tool to reduce income inequality. • Can be used to target specific products, for example
demerit goods. This will discourage the consumption of
demerit goods.
Disadvantages: Disadvantages:
• High tax rates may reduce incentive to work. • Contributes to inflationary pressures.
• High tax rates may reduce investment spending. • Worsens income inequality.
• As income rises, the percentage • As income rises, the percentage • As income rises, the percentage
(proportion) of income paid in (proportion) of income paid in (proportion) of income paid in tax
tax increases. tax falls. stays constant.
• Average rate of tax rises. • Average rate of tax falls. • Average rate of tax is constant.
In reference to the table above, the difference between progressive tax system, regressive tax system and proportional tax
system can be seen from the percentage of income paid in tax.
Tax can be used to redistribute income to achieve greater equality. Government uses the progressive tax system, where
high income earners are taxed proportionally more than the poor. Thus, high income earners have a higher average tax
rate while low income earners have a low average tax rate.
a) Anna’s yearly income is $80,000. Based on the table above, calculate the total tax paid by Anna.
Taxable income
Your answer:
c) Anna’s marginal tax rate is 50% because she paid 50% in tax on the last $1 earned.
Note that the average tax rate is always lower than the marginal tax rate. This is because all income earners can earn
a portion of their income ‘tax free’.
Apart from using the progressive tax system to reduce income inequality, government can also impose taxes to
reduce wealth inequalities.
1. Inheritance tax. Individuals who inherit more than a certain amount of wealth have to pay some of
the value of that wealth in tax to the government.
2. Capital tax. The tax is payable on the financial gain a person may have made during the time he / she
owned the asset.
Payments made by government to individuals for the specific purpose of redistributing income from the rich to the poor.
Transfer payments are funded by the tax revenue collected.
i) Transfer payments can be in the form of cash benefits (examples: income support, child benefit and incapacity
benefits). These benefits are designed to protect families in certain circumstances whose income would otherwise
be very low.
ii) Transfer payments can also be in kind (examples: health and education). These benefits accrue to individual
households depending on the number of members of household, their age and gender.
• Some of the benefits (in cash or in kind) are only paid to those whose
• Some of the benefits (in cash or in
income falls below a certain level. This is known as means-tested
kind) are paid to all, regardless of
benefit.
income, if they fall into a certain
category or fulfil certain conditions
(e.g. with children, of a certain age, a • Means-tested benefit is regarded as a much more efficient system as
disability). the money is directed to those most in need.
• This is known as universal benefit. • To obtain means-tested benefit, an individual must apply for them
and declare their personal circumstances to the authorities.
• Universal benefits imply paying out
money to many who do not need it However, means-tested benefit has a number of limitations / problems:
and thus tend to be expensive to
operate. • Disincentive to work:
o As poor people earn more money, they will have to start paying
income taxes and national insurance. In addition, they will also
begin losing means-tested benefits.
o Thus, the poor are discouraged from working or getting a better
job because any extra income earned will be largely taken away
in taxes and lost benefits. This situation is known as poverty
trap.
3. MINIMUM WAGE
• The policy of minimum wage was covered in the earlier part of this chapter. Refer to pages 7 & 8.
1. Examples: junior and secondary education and healthcare. Such services can be provided for free of charge to the user.
2. If these services are used equally by all citizens, then those on lowest incomes gain the most as a percentage of their income.
Inequality is thus reduced.
3. While education and healthcare markets are characterised by market failures (underconsumption and underproduction), these
failures by itself do not justify free provision to the consumer.
4. Instead, the free provision of such services must be on the grounds of equity, rather than on the grounds of underconsumption
or underproduction. This means that everyone should have access to a certain level of healthcare and education regardless
of income and wealth.
• Governments rarely possess complete information on which to formulate policies. Information available may also be
misleading causing governments to implement the wrong policy in response to a problem.
• Government may not know the full costs and benefits of its policies. It may genuinely wish to pursue the interests of
consumers or any other group but may not be aware of people’s wishes or may misinterpret their behaviour.
Market distortions
• In some cases, government intervention to correct a market failure leads to the creation of more market failures.
• Example: government subsidy policy. Government subsidy to farmers to help raise their incomes may lead to increases in
supply which may not be matched by an increase in demand. This will result in an oversupply of the good.
• Example: minimum wage policy. Government may want to raise incomes of the poor by setting a minimum wage. However,
this may raise production costs leading to firms laying-off workers.
It is impossible to draw firm conclusions about the optimum level of government intervention. This is partly due to the difficulties of
measuring costs and benefits of intervention and partly due to difficulties of predicting the effects of government policies, especially
over the long-term. Nonetheless, government intervention remains an important element in reducing failures of the market.