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Government Intervention and Its Shared Cost
Definition
Government intervention
When a government alters the resource allocation that markets would have achieved working freely on their own.
- Governments step into markets to change the price and quantity buyers and sellers would reach on their own.
- They do it to keep essentials affordable, discourage harmful goods, raise revenue, and correct over- or under-production.
- There are six main tools: price controls, indirect taxes, subsidies, direct provision, command-and-control regulation, and consumer nudges (HL).
- Almost every tool helps one group and hurts another, and most leave a welfare loss by moving the traded quantity away from where marginal benefit equals marginal cost.
Price Ceilings: A Maximum Price That Creates Shortages
Definition
Price ceiling
A maximum price, below the equilibrium price, set by the government for a particular good or service.
- A price ceiling is a legal maximum, so sellers cannot charge more, and it bites only when set below equilibrium.
- Governments use it on essentials like food staples and rents to keep them affordable.
- At the ceiling, quantity demanded rises while quantity supplied falls, so a shortage forms.
- Producers supply fewer units at a lower price, so producer surplus shrinks and the lost trades leave a welfare-loss triangle.
Case study
- New York rent controls hold rents below market levels, so protected tenants pay far less.
- The trade-off is a chronic housing shortage, as landlords supply fewer controlled units than tenants want.
- Venezuela capped food prices below equilibrium, producing empty shelves and long queues as supply dried up.
Calculating a Price Ceiling (HL)
- On the diagram the market clears at $P^* = 33$ and $Q^* = 165$, and the ceiling is set at $P_c = 19$.
- At $P_c = 19$, quantity supplied falls to $Q_s = 88$ while quantity demanded rises to $Q_d = 248$, so the shortage is $Q_d - Q_s = 248 - 88 = 160$ units.
- The welfare loss is the triangle between demand and supply over the lost units: $\frac{1}{2} \times (Q^* - Q_s) \times (47 - P_c) = \frac{1}{2} \times 77 \times 28 = 1{,}078$.
Price Floors: A Minimum Price That Creates Surpluses
Definition
Price floor
A minimum price set by the government for a good, above the equilibrium price.
- A price floor is a legal minimum, so sellers cannot sell below it, and it bites only when set above equilibrium.
- Governments use it to protect producers or low-paid workers.
- At the floor, quantity supplied rises while quantity demanded falls, so a surplus forms.
- To hold the price at the floor, the government usually buys the surplus, shifting demand to $D_{gov}$.
- In the labour market the roles flip: a minimum wage above equilibrium can create a surplus of labour, meaning unemployment.
Case study
- Seattle phased in a 15 dollar minimum wage from 2015, raising the wage floor for low-paid workers.
- A University of Washington study found employers cut hours, so affected workers earned about 125 dollars less per month.
- A Berkeley study found no significant job losses for restaurant workers, so economists disagree on the size of the effect.
Calculating a Price Floor (HL)
- The market clears at $P^* = 33$ and $Q^* = 165$, and the floor is set at $P_f = 47$.
