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Questions and Answers
What is one potential consequence of implementing maximum prices in a market?
What is one potential consequence of implementing maximum prices in a market?
How do subsidies primarily affect producer surplus?
How do subsidies primarily affect producer surplus?
What is a likely result of a unit tax imposed on a product with inelastic demand?
What is a likely result of a unit tax imposed on a product with inelastic demand?
Which method of government intervention involves setting a price below equilibrium?
Which method of government intervention involves setting a price below equilibrium?
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What typically happens to the quantity supplied when subsidies are placed on goods with elastic demand?
What typically happens to the quantity supplied when subsidies are placed on goods with elastic demand?
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What is a common consequence of imposing minimum prices in a market?
What is a common consequence of imposing minimum prices in a market?
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How does a maximum price affect the production quality of goods?
How does a maximum price affect the production quality of goods?
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In comparison to a unit tax, what distinguishes an ad valorem tax?
In comparison to a unit tax, what distinguishes an ad valorem tax?
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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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