Government intervention
When a government alters the resource allocation that markets would have achieved working freely on their own.
Governments may intervene to influence the market outcomes to:
- Earn government revenue.
- Support firms.
- Support households on low income.
- Influence level of production.
- Influence level of consumption.
- Correct market failure.
- Promote equity.
Earning Government Revenue
Governments need finances in order to finance public goods and services. Therefore, governments intervene in the markets to gain this revenue through:
- Indirect taxes
- Direct taxes.
Indirect taxes
Indirect taxes
Taxes levied on spending on goods and services. They are called indirect because while consumers contribute to part or all of the tax, it is the suppliers (firms) who collect and transfer these taxes to the government authorities (consumers pay the taxes indirectly).
The two types of indirect taxes are:
- Value Added Tax(VAT)
- Excise Tax
Governments may impose excise taxes on demerit goods such as cigarettes or alcohol, to discourage their use within the society.
Direct Taxes
Direct tax
Tax paid to the government directly by the taxpayer (individual).
Types of direct taxes include: Income tax, Property tax, and Wealth tax.
- Apart from collecting government revenue, direct taxes also promote equity by ensuring that people with higher incomes pay higher taxes (progressive taxation).
- Therefore, direct taxes are used by governments not only for funding public spending, but also to achieve income and wealth redistribution.
Supporting Firms
Governments frequently intervene in markets to support firms. They may do so to:
- Help small firms with financial assistance in order to increase their ability to compete.
- Encourage the growth of desirable industries e.g sustainable energy production.
- Protect domestic producers from more efficient foreign producers.
- Governments can help firms through the following:
- Subsidies for raw materials or required materials, to reduce costs of production
- Direct Provision of goods
- Trade protectionism policies such as quota and tariff to protect domestic firms (discussed in Global Trade)
