Government Intervention to Address Market Failure | Economics for GCSE/IGCSE - Year 11 PDF Download

Intervention to Address Market Failure

• Four of the frequently employed strategies to tackle market failure in markets consist of indirect taxation, subsidies, price ceilings, and price floors.
• Additional intervention methods encompass regulation, government ownership, transferring ownership to private entities, and the state's provision of public goods.

Maximum Prices

• A maximum price, established by the government, is set below the prevailing free market equilibrium price. Sellers are prohibited from selling the goods or services above this price point.
• Governments commonly implement maximum prices to benefit consumers. These price controls may be enforced over extended periods, such as in housing rental markets, or as short-term measures to address sudden price surges, like those seen in the petrol market.

Diagram Analysis:

• The market equilibrium initially stands at P_e and Q_e.
• Introduction of a maximum price at P_max alters the equilibrium:
  • Reduced supply incentive causes QS to contract from Q_e to Q_s.
  • Increased demand incentive leads to an extension in QD from Q_e to Q_d.
  • This mismatch results in excess demand (Q_s< />_d).

The Advantages & Disadvantages of Using Maximum Prices

Minimum Prices

• A minimum price is established by the government above the current free market equilibrium price. Sellers are prohibited from selling the good/service at a lower price.
• Governments often implement minimum prices to support producers or reduce the consumption of demerit goods such as alcohol.

Diagram Analysis:

• The market initially balances at price P_e and quantity Q_e.
• When a minimum price (P_min) is enforced:
  • Higher prices incentivize suppliers, increasing quantity supplied from Q_e to Q_s.
  • Higher prices discourage consumers, decreasing quantity demanded from Q_e to Q_d.
  • This discrepancy leads to excess supply (Q_d > Q_s).

The Advantages & Disadvantages of Using Minimum Prices In Product Markets

Minimum Prices in Labour Markets

• Minimum prices are applied in the labor market to safeguard workers against wage exploitation, termed as national minimum wages (NMW).
• NMW denotes a legally mandated wage floor that employers are obligated to remunerate their employees, set higher than the prevailing market rate.
• The hourly minimum wage varies depending on the worker's age.

Diagram Analysis:

• The Concept of Labour Market Equilibrium:
  • The demand for labor (D_L) signifies the necessity for workers as indicated by firms.
  • The supply of labor (S_L) denotes the availability of labor provided by workers.
  • Market equilibrium for truck drivers in the UK is observed at a wage rate of W_e and quantity Q_e.
• National Minimum Wage Impact:
  • The UK government enforces a national minimum wage (NMW) set at W₁.
  • Due to higher wages, the supply of labor escalates from Q_e to Q_s.
  • Facing increased production costs, firms' demand for labor diminishes from Q_e to Q_d.
  • Resultingly, at wage rate W₁, there exists an excess supply of labor leading to potential unemployment, quantified at Q_d to Q_s.

The Advantages & Disadvantages of a Minimum Wage In Labour Markets

Indirect Taxation

• An indirect tax is a type of tax imposed on the consumption of goods and services. It is paid by consumers when they make a purchase.
• Typically, governments levy indirect taxes on demerit goods to decrease the quantity demanded (QD) and/or to increase government revenue. The revenue generated is then utilized to finance public services such as education.
• These taxes are imposed on producers, leading to shifts in the supply curve. Both producers and consumers bear a portion of the tax burden, known as the tax incidence.

Diagram Analysis:

• The government imposes a specific tax on a demerit good, causing the supply curve to shift from S₁ to S₂ by the amount of the tax.
• The consumer's price increases from P₁ to P₂ after the tax.
• The producer's price decreases from P₁ to P₃ post-tax.
• The government's tax revenue is calculated as (P₂ - P₃) x Q₂.
• Consumer incidence of the tax (area A) is (P₂ - P₁) x Q₂.
• Producer incidence of the tax (area B) is (P₁ - P₃) x Q₂.
• The quantity demanded (QD) decreases from Q₁ to Q₂, potentially leading to worker layoffs if significant enough.

The Advantages & Disadvantages Of Indirect Taxes

Producer Subsidies

• A producer subsidy is a monetary incentive provided by the government to firms with the aim of boosting production and promoting the provision of goods that are considered beneficial to society.
• These subsidies are implemented to encourage firms to increase their output and to support the production of goods that have positive externalities, such as merit goods like education or healthcare.
• When a subsidy is granted, the division of its benefits between producers and consumers is influenced by the price elasticity of demand (PED) for the specific product.
• Producers typically retain a portion of the subsidy and pass on the remainder to consumers through reduced prices, aiming to stimulate demand for their products.

Diagram Analysis:

• The original equilibrium price and quantity are denoted by P₁ and Q₁.
• Introducing a subsidy causes the supply curve to shift, resulting in an increase in quantity demanded from Q₁ to Q₂. This change leads to a new market equilibrium at price P₂ and quantity Q₂.
• This shift in equilibrium signifies a reduction in price and an increase in quantity demanded within the market.
• Producers receive a price of P₂ from the consumer along with a subsidy per unit from the government. This results in the producer revenue being P₃ x Q₂. The portion of the subsidy that goes to the producer is denoted as B in the diagram.
• The subsidy effectively reduces the price consumers pay from P₁ to P₂. The consumer's share of the subsidy is represented as A in the diagram.
• The total cost incurred by the government due to the subsidy amounts to (P₃ - P₂) x Q₂, which is visually indicated by the area A + B.
• Producers receive P₂ from consumers in addition to a subsidy per unit from the government. Consequently, the producer's revenue equals P₃ x Q₂. The section of the subsidy allocated to the producer is identified as A in the diagram.

The Advantages & Disadvantages Of Producer Subsidies

Other Government Policy Measures to Address Market Failure

Other Methods Used to Address Market Failure