Government Intervention SL (Tragakes Chapter 4 pages )

1 Government Intervention SL (Tragakes Chapter 4 pages 74-100) Price Ceiling Price ceiling – a regulation making it illegal to charge a price higher...
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Government Intervention SL (Tragakes Chapter 4 pages 74-100)

Price Ceiling Price ceiling – a regulation making it illegal to charge a price higher than a specified level; set below equilibrium to be effective; an example is rent control Unregulated market – a market with no regulations, governed by market forces of supply and demand Short-run – some factors may be varied in response to changes in supply and/or demand Long-run – enough time has elapsed for the market to respond fully to changes in supply and/or demand

Rent Ceiling

Rent (USD per month)

USD

0

Q Housing for Rent (number of units)

Shortage – excess quantity demanded at a particular price; the difference between the quantity demanded and the quantity supplied at a particular price

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Milk

Price (THB/liter)

THB

0

Q Milk (liters per week)

Parallel (Black) Market – illegal trading arrangement in which buyers and sellers do business at a price that is higher (in the case of ceilings) than the legally imposed price How well a price ceiling functions depends on: a. how tightly government polices regulations b. chances of being caught violating the regulations c. scale of penalties involved for the violations Results of having a price ceiling: Price ceilings result in shortages – producers are not encouraged to produce more Prices no longer allocate products (in this example – housing units) allocation becomes an issue; how to ration Consumers willing and able to pay a higher price cannot get the product (e.g. housing units) Landlords have no incentive to provide more of the product (e.g. housing units) Parallel market (black market) may also develop for the product (e.g. key money, illegal sublets, smuggled goods) Non-price rationing systems – ration coupons, quota limits (eggs and water in Bangkok during the flood); increased government administrative costs

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Price Floor Price floor – a regulation making it illegal to charge a price lower than a specified level, set above equilibrium to be effective examples would be minimum wage and agricultural price supports Minimum Wage Laws

Real Wage Rate (THB/hr)

W

0

L Labor (unemployment)

Excess labor – Quantity supplied of labor exceeds quantity demanded of labor Demand for some kinds of labor, especially least skilled type, is constantly decreasing Minimum wage – a law that makes trading labor below a specified wage illegal Surplus Labor (unemployment) – excess quantity supplied of labor at a particular wage; the difference between the quantity supplied and the quantity demanded at a particular wage  increases unemployment - hits young and unskilled the hardest  lowers the quantity of labor demanded and hired  Increasing wages increases the cost of production of goods and services, decreases supply, and raises prices for consumers  surplus of labor at the minimum wage which is unemployment of those who had a job but lose it and of those who join the labor force because they are satisfied with the new wage  cost to society in terms of unemployment benefits and welfare payments (food stamps and other programs) paid by the government from taxes  inefficient allocation of the factor of production – labor  Living wage

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Rice

Rice (THB/kg)

THB

0

Q Rice (kgs)

Surplus output – excess quantity supplied of output at a particular price; the difference between the quantity supplied and the quantity demanded at a particular price      

increases output which may not be sold which the government has to deal with lowers the quantity of output demanded – less for consumers when supported good is used as an input, the cost of production increases, supply decreases and the prices for consumers increase cost to society in terms of inefficient allocation of resources – other products could be produced with the factors of production usually supported by a government purchase program which diverts government resources (tax revenues) from other programs government may dispose of surpluses through aid programs or, in some cases, use as a buffer stock

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Subsidies Subsidy – a payment of funds (or goods and services) by a government, firm or household for which it receives no good or service in return. When made by the government, it is a public transfer payment. Government can pay subsidies or grant tax relief to producers in order to  compensate for low market prices  increase competitiveness by reducing costs of production (particularly in the export market)  increase supply of a desired output by decreasing costs of production (corn for bio-fuels)  provide incentives for the production of a desired good or service (education)

Subsidies on Steel

Price (THB/ton)

P

0

Q Steel (millions of tons)

Effects of subsidies: Government – ability to pay or not, shifts resources away from other sectors of the economy, food security Producer – could become less competitive or less efficient Consumer – gains by receiving a lower price (however taxes have to be collected to pay the subsidies) Notes Government Intervention SL 1213SL 1213 13 January 2012

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Agricultural Subsidies can be used to increase farm incomes as well as to stabilize them a per-unit-of-output subsidy encourages farmers to produce more which depresses market price Direct income support (or direct aid) – a fixed grant to farmers that does not vary with current output; may be based on acreage, number of livestock, or past output since subsidy is not related to output, no incentive to produce more

Effect of Subsidies on Wheat

Price (THB/ton)

P

0

Q Wheat (millions of tons)

Notes Government Intervention SL 1213SL 1213 13 January 2012

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High Minimum Prices If country is a net importer and assuming desired domestic price is above world price, government needs to impose customs duties (tariffs or import levies)

Minimum Price (where some of the wheat is imported)

Price (THB/ton)

P

0

Q Wheat (millions of tons)

Minimum price for a country that is self-sufficient in the agricultural product works as a price floor.

Other methods to reduce supply of agricultural output 

Give farmers a quota as to how much each farmer was allowed to produce



Limit the amount of land a farmer can use for a particular product



Require farmers to withdraw a certain percentage of their land from agricultural use

All three of the above would shift the supply curve leftward, reducing supply

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Structural policies to reduce supply of agricultural products Government provide retraining or financial help for people to exit agriculture Government provide grants or other incentives for farmers to diversify into forestry, tourism, organically grown crops, or crops with a high income elasticity of demand (such as Thailand is trying to do) sectoral change from primary (agriculture) to: secondary (manufacturing) tertiary (services)

Consumer and Producer Surplus Consumer Surplus

Producer Surplus

EUR

EUR

D

D

S

S

S1

Price (EUR/kg of rice)

Price (EUR/kg of rice)

S1

0

Kg Rice (kgs)

0

Kg Rice (kgs)

Discuss the consequences of providing a subsidy on the stakeholders (economic actors in a market: Consumers Producers Government

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Indirect Taxation Direct tax – taxes on income and wealth paid directly to the government by households Indirect tax – taxes on expenditure (e.g., VAT – value added tax)

Paid to the tax authorities, not directly by the consumer, but indirectly through the producers of the goods and services who consider these taxes a cost of production and pass them on to the consumer. Examples are: 

Excise tax – a tax levied on the production of a specific product or on the quantity of the product purchased



Sales tax – an excise tax levied on the cost (at retail) of a broad group of products; a single-stage tax



Value added tax (VAT) - a multi-stage tax on goods and services charged at each stage of production as a percentage of the value added at that stage

Taxes may be levied by means of a(n): 

Ad valorem tax – a tax on a good levied as a percentage of its value.



Specific tax – fixed amount per unit sold, e.g., the tax per liter of petrol

When a tax is added it shifts the supply curve left by the amount of the tax; a specific tax causes the new S curve to be parallel while an ad valorem tax will cause the new S curve to “swing” left

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Supply Curve Demonstrating Effect of a Tax

Price (THB)

P

0

Q iPad (thousands of units)

Vertical distance between the curve S and the curve S + Tax equals the tax The curve S + Tax describes the terms on which a good is available to buyers

Effect of a tax is to raise price and reduce quantity Price will not rise by the full amount of the tax Consumers pay to the extent that price rises Producers pay to the extent that this rise in price is not sufficient to cover the tax

Effect of tax on economic actors: Consumers pay a higher price Producers receive a lower price, produce less output Government gains tax revenues and is redistributing income (from households and firms to government programs) Societal welfare may be reduced with regard to the product as allocative efficiency is not achieved and there is an inefficiency of the tax (output that is lost as well as loss of consumer and producer surplus)

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Elasticity and Indirect Taxes

Price (THB)

P

0

Q iPad (thousands of units)

Elasticity and Indirect Taxes

Price (THB)

P

0

Q iPad (thousands of units)

Who pays the tax (the producer or the consumer) and how much of the tax they pay depends on the elasticity of the supply and the elasticity of the demand of the good or service in question

Notes Government Intervention SL 1213SL 1213 13 January 2012

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Consumer surplus – the difference between what a consumer is willing to pay for an additional unit of a good or service and its market price. Producer surplus - the difference between what a producer is willing to sell an additional unit of a good or service for and its market price. Allocative efficiency - apportionment of resources among firms and industries to obtain the production of the products most wanted by society (consumers); Private allocative efficiency versus social allocative efficiency

Taxation and Consumer/Producer Surplus

Price (THB)

P

0

Q iPad (thousands of units)

Notes Government Intervention SL 1213SL 1213 13 January 2012