Government Intervention in Markets

Government Intervention

• Government intervention in markets occurs when the government modifies market activities.
• Reasons government intervenes include providing essential services (e.g., electricity, water) and correcting market failures or inefficiencies (e.g., drugs, monopolies).
• Price controls are interventions that affect prices.

Price Controls

• Price Ceiling: A legal maximum price at which a good can be sold (e.g., bread, rent control).

• A price ceiling below the equilibrium price results in a shortage (quantity demanded exceeds quantity supplied).

• Price Floor: A legal minimum price at which a good can be sold (e.g., minimum wage).

• A price floor above the equilibrium price results in a surplus (quantity supplied exceeds quantity demanded).

Taxes

• Taxes imposed on sellers affect prices and the market's quantity traded.
• Consumers indirectly bear a portion of the tax burden.
• Suppliers also bear a portion of the tax burden.
• The tax burden shifts depending on the elasticity of supply and demand (more inelastic side bears more of the burden).

Question 1A

• Binding price ceilings are those set below the equilibrium price.
• A binding price ceiling results in a shortage, where quantity demanded exceeds quantity supplied.
• At a binding price ceiling, a portion of consumers will have no way to access the product/good.
• Producers will be less incentivized to produce/offer as there's less profit.
• Equilibrium price where quantity supplied and quantity demanded meet.

Question 1B

• Binding price floors are those set above the equilibrium price.
• A binding price floor results in a surplus, where quantity supplied exceeds quantity demanded.
• If equilibrium price remains too low, there is a surplus of product in the market, as there are more producers than consumers.
• Producers will overproduce goods, resulting in a larger quantity available.

Question 2

• Tax imposed = amount paid by consumer - amount received by producer (seller).
• The tax burden is shared between consumers and producers (sellers).

Question 2 (Values)

• The value of the tax is $2.5, derived by subtracting the price received from the price paid by consumers.
• The price paid by consumers is 6,andthepricereceivedbyproducers(sellers)is6, and the price received by producers (sellers) is 6,andthepricereceivedbyproducers(sellers)is3.5.
• Equilibrium quantity x tax imposed = tax revenue, which in this case is $125.

Question 2 (Taxes)

• The tax burden falls more heavily on the side of the market with lower elasticity, either supply or demand.
• Supply side elasticity: the ease of adjusting production in response to price changes.
• Demand side elasticity: the ease of adjusting consumption in response to price changes.

Question 3 (Payroll Tax)

• Payroll tax: If imposed on employers, it will shift the supply curve to the left for labor.
• The result is an increase in the price for employees (wage); however, the amount of the wage increase is less than the tax amount.

Question 3 (Market Failures)

• Market failure occurs when the free market fails to allocate goods and services efficiently.
• Market failures occur in the cases of:
• Positive externalities or negative externalities.
• Inequality
• Natural monopolies
• Public Goods Production.

Question 3 (Price Floor/Tax)

• Tax on cigarettes (or any good) creates a price disequilibrium, where consumers pay more and producers receive less, with price differences equaling tax rate.
• A price floor increases the price and incentivizes producers to increase supply, but demand may not increase as much resulting in surplus.

Case 2 (Extra Exercise)

• When a payroll tax is proposed on firms, the tax incidence (burden) is divided between firms and employees (workers).
• The side with less elasticity (e.g., workers, especially lower income) bears most of the burden.
• Increasing payroll taxes on firms will likely increase tax revenue but decrease wages for workers.