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Questions and Answers

What is one potential consequence of implementing maximum prices in a market?

  • Shortages of goods (correct)
  • Increase in producer surplus
  • Increased consumer demand
  • Higher quality products

How do subsidies primarily affect producer surplus?

  • They lead to a decrease in market prices.
  • They impose additional taxes on producers.
  • They decrease production costs, increasing producer surplus. (correct)
  • They have no effect on producer surplus.

What is a likely result of a unit tax imposed on a product with inelastic demand?

  • Government revenue increases due to higher consumer prices. (correct)
  • Consumers pay significantly less than before.
  • Producers bear the entire burden of the tax.
  • The quantity demanded decreases drastically.

Which method of government intervention involves setting a price below equilibrium?

<p>Maximum prices (C)</p> Signup and view all the answers

What typically happens to the quantity supplied when subsidies are placed on goods with elastic demand?

<p>Quantity supplied promotes an increase. (D)</p> Signup and view all the answers

What is a common consequence of imposing minimum prices in a market?

<p>Excess supply of goods (B)</p> Signup and view all the answers

How does a maximum price affect the production quality of goods?

<p>Quality tends to decrease as production becomes less profitable. (A)</p> Signup and view all the answers

In comparison to a unit tax, what distinguishes an ad valorem tax?

<p>It is levied as a percentage of a good's value. (D)</p> Signup and view all the answers

Flashcards

Government Intervention

Actions taken by the government to influence the market, often to correct market failures, redistribute income, or promote equity.

Maximum Price

A legal limit on how high a price can be for a good or service.

Minimum Price

A legal minimum price for a good or service.

Subsidy

A government payment to encourage the production or consumption of a good or service.

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Tax Impact (Inelastic Demand)

When demand is inelastic, consumers bear a larger portion of a unit tax than producers.

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Equilibrium

The point where supply and demand intersect, determining the market price and quantity.

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Market Failure

A situation where the free market fails to allocate resources efficiently.

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Consumer Surplus

The difference between what consumers are willing to pay and what they actually pay.

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Study Notes

Government Interventions

  • In a free market, resources are allocated using the price mechanism.
  • Government intervention is used to correct market failures. This can include:
    • Redistributing income (e.g., progressive taxation, benefits like pensions and unemployment benefits).
    • Promoting equity (making things fair).
  • Methods of intervention include:
    • Taxes
    • Regulation
    • Minimum prices
    • Subsidies
    • Direct government provision
    • Maximum prices

Maximum Prices

  • Examples: rent control, pharmaceuticals, staple foods, energy.
  • Impact:
    • Can lead to queuing, assessment of needs, or a lottery system.
    • Can create illegal secondary markets
    • May reduce the quality of the good/service.

Minimum Prices

  • Example: minimum alcohol price
  • Impact:
    • Reduces consumer surplus
    • Increases producer surplus
    • Government gains revenue,
    • May decrease consumption of a good or service.

Taxes

  • Taxes impact consumer and producer surplus.
  • If supply/demand lines are parallel, it's a unit tax.
  • Specific/unit tax: fixed amount per unit (e.g., 52.95/liter).
  • Ad Valorem tax: percentage of the value of the good(e.g., 20% tax).
  • Impact on consumer/producer surplus and government revenue differs based on the elasticity of supply and demand.
    • Inelastic demand: consumers bear more of the burden.
    • Elastic demand: producers bear more of the burden.

Subsidies

  • Government payment to incentivize production.
  • Subsidies impact the supply curve (shift right).
    • Consumer surplus increases
    • Producer surplus increases
    • Govt spending on buying the good/service.
  • Impact on elasticity: inelastic demand, smaller impact on price

Elasticity

  • Demand elasticity: measure of responsiveness of demand to price changes.
    • Elastic demand: quantity demanded changes significantly with a change in price.
    • Inelastic demand: quantity demanded changes little with a change in price.
    • Impact on burden of tax: In the case of an inelastic demand, consumer bear more of the burden.
  • Supply elasticity: measure of responsiveness of supply to price changes.
    • Elastic supply: quantity supplied changes significantly with a change in price.
    • Inelastic supply: quantity supplied changes little with a change in price.

Equilibrium

  • Below equilibrium: supply is inelastic, and demand is inelastic
  • Above equilibrium: supply is elastic, and demand is elastic

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