2.7 Role of government in microeconomics

• Reasons for government intervention in markets:

  • earn government revenue
  • support firms
  • support households on low incomes
  • influence level of production
  • influence the level of consumption
  • correct market failure
  • promote equity
• Main forms of government intervention in markets:

  • price ceilings
  • price floors
  • indirect taxes and subsidies
  • direct provision of services
  • command and control regulation and legislation
• Price ceilings (maximum price) are used to:

  • increase consumption of the good or service
  • reduce the price of certain goods or services for low-income consumers
  • prevent exploitation by monopolies

  
• Possible consequences of imposing a price ceiling:

  • shortages
  • generates a rationing problem
  • promotes the creation of black markets
  • eliminates allocative efficiency and generates welfare loss
  • consequences for market stakeholders
• Price floors (minimum price) are used to:

  • increase the income of producers of goods and services that are subject to large price fluctuations or great foreign competition
  • to protect workers

  
• Possible consequences of imposing a price floor:

  • surplus
  • promotes the creation of black markets
  • government needs to dispose of surplus
  • might create firm inefficiency
  • eliminates allocative efficiency and generates welfare loss
  • consequences for market stakeholders
• Indirect taxes are taxes that are not imposed directly on people's income or wealth. They are paid indirectly by consumers when they purchase a good, as indirect taxes are included in the price of the good.
• Aims of indirect taxes are to:

  • collect government revenue
  • discourage consumption of undesirable and/or dangerous goods
  • redistribute income within the population
  • correct negative externalities
• There are two types of income taxes:

  • Specific tax - a fixed amount of tax imposed on a good or service per unit sold
  • Percentage tax / ad valorem tax - a fixed percentage charged on the selling price of the good

  
• Subsidies are per-unit payments that are used to lower production costs and increase the output of the market.

  
• Subsidies are used to:

  • increase revenue of producers
  • to make basic necessities and merit goods more affordable to low-income earners
  • to encourage consumption of goods with positive externalities
  • to support growth of a particular firm
  • to encourage exports and protect national firms from foreign competition
  • to correct positive externalities
• Direct provision of services is when the government provides services directly to the public.

  Eg. public transport, education, healthcare
• Regulation and legislation involve the government intervening in the markets through the legal system.