IB Economics 2.7.2 Main Forms of Government Intervention in Markets Notes

Government Intervention and Its Shared Cost

1. Governments step into markets to change the price and quantity buyers and sellers would reach on their own.
2. They do it to keep essentials affordable, discourage harmful goods, raise revenue, and correct over- or under-production.
3. There are five main tools: price controls, indirect taxes, subsidies, direct provision, and command-and-control regulation.
4. 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

1. A price ceiling is a legal maximum, so sellers cannot charge more, and it bites only when set below equilibrium.
2. Governments use it on essentials like food staples and rents to keep them affordable.
3. At the ceiling, quantity demanded rises while quantity supplied falls, so a shortage forms.
4. Producers supply fewer units at a lower price, so producer surplus shrinks and the lost trades leave a welfare-loss triangle.

Price Floors: A Minimum Price That Creates Surpluses

1. A price floor is a legal minimum, so sellers cannot sell below it, and it bites only when set above equilibrium.
2. Governments use it to protect producers or low-paid workers.
3. At the floor, quantity supplied rises while quantity demanded falls, so a surplus forms.
4. To hold the price at the floor, the government usually buys the surplus, shifting demand to $D_{gov}$.
5. In the labour market the roles flip: a minimum wage above equilibrium can create a surplus of labour, meaning unemployment.

Indirect Taxes: Shifting Supply to Raise the Price

1. An indirect tax is charged on a good and raises the price consumers pay; producers collect it and hand it over, so it raises costs and shifts supply left.
2. A specific tax is a fixed amount per unit, while an ad valorem tax is a percentage of the price.
3. The tax lifts supply to $S_1 + \text{tax}$, so quantity falls and consumers pay a higher price while producers keep less after handing the tax over.
4. Consumers pay more, producers receive less, the government collects revenue, and a welfare-loss triangle opens.

1. An ad valorem tax works the same way but pivots the supply curve steeper, because a percentage adds more tax as the price rises.

Subsidies: Shifting Supply to Lower the Price

1. A subsidy is a payment to producers that lowers their costs and the price consumers pay, so it shifts supply right.
2. Governments subsidise to make essentials affordable, encourage needed production, boost exports, and grow target industries.
3. Supply rises to $S_1 + \text{subsidy}$, so quantity rises; consumers pay less and producers receive more, with the government paying the gap on every unit.
4. Consumer and producer surplus both rise, but output is pushed past the efficient level, so the spending includes a welfare loss.

Direct Provision: Supplying the Good Itself

1. Sometimes the government supplies a good itself rather than leaving it to private firms.
2. It does this when the market fails to meet a need, when it wants a good like healthcare open to everyone, and when it wants to keep quality high.
3. Because the good is free or heavily discounted at the point of use, access no longer depends on ability to pay.
4. But a state provider faces no competition and can become inefficient, and it is funded from tax revenue, which has an opportunity cost.

Command and Control: Ruling Behaviour by Law

1. Command and control uses laws to change market outcomes directly, without altering price.
2. Rules can fix inefficiencies that appear when firms and consumers will not act voluntarily, and cut risks to public welfare quickly.
3. The tools include emission limits that cap pollution, safety standards that set minimum product quality, and labour laws such as a minimum wage.
4. But new laws take time to pass, and enforcement costs resources funded from tax revenue, which has an opportunity cost.

Comparing the Tools: Who Wins and Who Loses

1. Each price and tax tool helps one side and hurts another: a ceiling favours consumers, a floor and a subsidy favour producers, and a tax favours government revenue.
2. Every one of them moves the traded quantity away from the efficient level, so each leaves a welfare loss.
3. Direct provision and regulation work without changing price, but they still use resources or rely on people responding.