MICROECONOMICS
GOVERNMENT INTERVENTION
Reasons for Government Intervention
1) Correcting Market Failure
Market failures occur when the allocation of goods and services by a free market is not efficient. Governments intervene to correct these failures and improve social welfare.
2) Earning Government Revenue Governments need revenue to fund public services and infrastructure. This revenue is often raised through taxation and other means.
Externalities: External costs or benefits that affect third parties who did not choose to incur that cost or benefit
Public Goods: Goods that are non-excludable and non-rivalrous
Merit and Demerit Goods: Merit goods (e.g., education. are under-consumed, while demerit goods (e.g., tobacco) are over-consumed in a free market
Taxes: Levies on income, consumption and property
Privatisation: Selling state-owned enterprises to private entities
Licenses and Fees: Charging for the right use certain resources or operate in certain markets
3) Equity involving reducing the gap between the rich and the poor to ensure a fair distribution of resources
Progressive Taxation: Higher tax rates on higher income brackets
Welfare Programs: Financial assistance to low-income households
Minimum wage laws: Ensuring workers receive a living wage
4) Supporting firms: In a global economy, governments may support domestic industries to enhance their competitiveness
Subsidies: Financial assistance to reduce production cost
Trade Protection: Tariffs and quotas to limit foreign competition
Tax Breaks: Reductions in tax liabilities to encourage investment
5) Assisting poorer households Implementing redistribution policies to alleviate poverty and improve living standards
Welfare Payments: Direct financial assistance to low-income individuals and families
Indirect Taxes and Subsidies
Indirect taxes: Levied on goods and services rather than on income or profits and received by government
Specific Taxes: Fixed amount per unit of the good or service (e.g., excise duty on cigarettes
Can be used to discourage consumption of goods (demerit goods) and to generate revenue
Tax Revenue = Tax Rate x Quantity Sold
Subsidies: Financial support provided by the government to encourage the production or consumption of certain goods and services
Production Subsidies: Lowers the costs of production of firms
Consumption Subsidies: Lower the price for consumers
Price Controls, Direct Provision and Regulation
Price Controls: Government-imposed limits on the prices that can be charged for goods and services
Price Ceilings: (Maximum Prices) Set below the equilibrium price to make goods more affordable
Price Floors: (Minimum Prices) Set above the equilibrium price to ensure producers receive a minimum income
Direct Provision: Government directly provides goods and services, particularly in sectors where private provision is insufficient or inefficient
Public Goods: Non-excludable and non-rivalrous goods provided by the government (e.g., army)
Merit Goods: Goods that are under-consumed in a free market (e.g., education, healthcare)
Regulation: Government creates rules and regulation to control market activities and protect consumers and the environment
Consumer Protection Laws: Ensuring product safety and fair trading practices
Environmental Regulations: Limits on pollution and resource use
Labor Laws: Protecting workers' rights and ensuring safe working conditions
MARKET FAILURE
Ad Valorem Taxes: Percentage pf the price of the good and service (e.g., VAT)
A situation where the free market, operating on its own, does not allocate resources efficiently from the perspective of society as a whole
Scarce Resources: Land, labour, capital and enterpreneurship
Price Mechanism: In a free market, prices are determined by the forces of supply and demand (should lead to an efficient allocation of the scarce resources)
Allocative efficiency occurs when resources are distributed in a way that maximizes the net benefit to society
MSB=MSC
1) EXTERNALITIES
occur when the consumption or production of a good affects a third party who did not choose to incur that cost or benefit
2) PUBLIC GOODS
3) COMMON POOL RESOURCES
4) ASYMMETRIC INFORMATION
goods that are non-excludable and non-rivalrous, leading to under-provision in a free market.
resources that are non-excludable but rivalrous, leading to overuse and depletion
occurs when one party has more or better information than the other, leading to an inefficient market outcome
Negative Externalities: These are harmful effects, such as pollution
Positive Externalities: These are beneficial effects, such as vaccinations
MARGINAL ANALYSIS
Marginal Private Benefit (MPB): The additional benefit received from consuming or producing one more unit.
Marginal Private Cost (MPC): The additional cost incurred from consuming or producing one more unit.
Marginal Social Benefit (MSB): The total benefit to society, including both private and external benefits.
Marginal Social Cost (MSC): The total cost to society, including both private and external costs.
Socially Optimum Output occurs where MSB = MSC. At this point, the allocation of resources is considered efficient from society's perspective.
Occur when the production or consumption of a good imposes costs on third parties.
Occur when the production or consumption of a good provides benefits to third parties.
The free-market equilibrium is where MPC=MSB
The socially optimal equilibrium is where MSC=MSB
The gap between MPC and MSC is the external costs
The free-market equilibrium is where MPB=MSC
The socially optimal equilibrium is where MSB=MSC
The gap between MPB and MSB represents the external benefit
Example: National defense
Non-excludable: It's not possible to exclude individuals from consuming the good
Non-rivalrous: One person's consumption does not reduce availability for others
Example: Fisheries
Non-excludable: It's difficult to prevent people from using the resource
Rivalrous: One person's use of the resource reduces its availability for others
Taxes and Subsidies to internalize externalities
Regulation to limit harmful activities
Government Intervention
Government Intervention
Provision of Public Goods to ensure adequate supply
Government Intervention
Property Rights to manage common pool resources
DEMAND AND SUPPLY
Unsustainable production refers to the production that uses resource unsustainably leading to depletion or degradation
DEMAND
Negative production externalities refer to external costs created by products
POLICIES TO CORRECT
INTERNATIONAL AGREEMENTS
COLLECTIVE SELF-GOVERNANCE
EDUCATION AND AWARENESS CREATION
GOVERNMENT LEGISLATION AND REGULATION
MARKET BASED POLICIES
Carbon Taxes refers to a tax per unit of carbon emission of fossil fuels
Advantages
Demand : Quantities of a good that consumers are willing and able to buy at different possible prices during a particular time period.
Law of demand : there is a negative relationship between price of a good and quantity demanded. eg = as the price of the good increases, the quantity of the good demanded falls (vice versa)
Non price determinants (demand)
Provide incentives to producers to reduce the quantity on the output produces
Provide incentives to firm to economise on the use of polluting resources
Income in the case of normal goods = an increase in income leads to a rightward shift in the demand curve (vice versa)
Disadvantages
Taxes
Enviromental degradation: wealthy companies can continue to pollute even with high taxes
can lead to conflict between firms and government
can cause to only focus on competition and not customer value
indirect taxes that are imposed are regressive, meaning that lower income people have to pay a higher proportion of their income in tax than higher income people
Tradable permit
Government or international body have to set a maximum acceptable level for each type of pollutant
Indirect (Pigouvian) Tax to lead to allocative efficiency
Advantages
Easier to implement
can avoid the technical difficulties that arise in the use of market-based solutions
can force firms to comply and reduce their harmful activities
Disadvantages
do not offer incentives to reduce emissions by using less polluting resources, to increase energy efficiency, to switch to alternative fuels
Only partially effective in reducing the pollution created
costs to monitor and supervise the possible violations
Market Equilibrium : Occurs where quantity demanded is equal to quantity supplied, and there is no tendenc for the price to change.
calculated based on how much carbon the fuel emits
method of addressing market failure by having a community work together to solve the negative externalities of common pool resources
Market Demand : is the sum of individual demand for a good.
SUPPLY
Supply : Quantities of a good that firms are willing and able to produce and sell at different possible prices during a particular time period.
Law of supply ; there is a positive relationship between price of a good and quantity supplied. eg = as the price of the good increases, the quantity of the good supplied increases (vice versa)
income in the case of inferior goods = an increase in income leads to a leftwardshift in the demand curve because consumer switch to more expensive alternatives. (vice versa)
Preference and taste = if the preference and taste change in favour of a product ( it becomes more popular ) Demand increases and demand shift to the right (vice versa)
prices of substitute goods (satisfy similar needs) = A fall in the price of Coke results in a fall of demand of Pepsi (vice versa) consumer substitute to good b
Prices of complementary goods(they tend to be used together) = a fall in price of computer leads to an increase of demand for the computer software.
The numbers of consumers = if there is an increase in the number of consumers(demanders) demand will increase and demand curve shift to the left.
Tradable Permit refers to a policy involving permits to pollute issued to firms by a government or international body
Regarding the polluting activities of firms. Firms are forced to take consumers' opinions into consideration and change their production methods in order to reduce the externalities
Advantage: Firms are influenced by what customers want to keep them happy
Disadvantages: Can only make a small difference in terms of solving the problem of production externalities and sustainability
to limit the total amount of pollutants emitted by the firms
Montreal Protocol, EU Emission Trading System, EU Allowance, Kyoto Protocol, Paris Agreement
Negative consumption externalities refer to external costs created by consumers
POLICIES TO CORRECT
MARKET BASED POLICIES
Tax and Subsidy
Advantage: create incentives for consumer to change their consumption patterns
Disadvantage: Difficulties in measuring the value of the external costs
GOVERNMENT LEGISLATION AND REGULATION
Advantage: Can be very effective in reducing the external costs of certain consumption activities
Disadvantage: cannot be used to deal with other kinds of negative consumption externalities
EDUCATION AND AWARENESS CREATION
Anti-smoking campaigns, unhealthy food, reduce fossil fuels, etc
Advantage: Simpler than other methods
Disadvantages: Cost of the campaigns, may not be effective enough to reduce externality
NUDGES
Positive production externalities refer to external benefits created by producers
Positive consumption externalities refer to external benefits created by consumers
GOVERNMENT PROVISION
HL
Engagement in R&D for new technology, medicine and pharmaceuticals. Training for workers.
SUBSIDIES
Increase quantity produced and to lower the price
Benefits the person who receives the education - more productive workforce, lower unemployment, higher rate of growth, more economic development, lower crime rate
GOVERNMENT LEGISLATION AND REGULATION
To promote greater consumption of goods with positive externalities
EDUCATION AND AWARENESS CREATION
NUDGES
DIRECT GOVERNMENT PROVISION
Examples: Healthcare and education
Increase supply and achieve social optimum
SUBSIDIES
Examples: schooling up to a minimum age or education on the importance of good nutrition
Disadvantages: Only sometimes can they be effective, Ineffective, Have further effect of raising the price of good to consumers
Disadvantages: Government relying on tax revenues, Difficult to measure the size of the external benefits
Contracting out to the private sector
Free rider problem refer to when some people take advantage of a shared resource without paying their fair share
When a government makes an agreement or contract with a private firm to carry out an activity that the government was previously doing itself
SUMMARY
Rivalrous & Excludable
Non-rivalrous & Excludable
Rivalrous & Non-excludable
Non-rivalrous & Non-excludable
National defence, street lighting
Forests, rivers, lakes, soil quality, fish in the oceans
Museums, public swimming pool that charges entrance fee, quasi-public goods
Computers, books, clothes, education, petrol
Adverse Selection
Moral Hazard
Situation when one party in a transaction has more information about quality of product being sold than the other party
Information is available to sellers but not buyers
- Consumers are likely to be aware of possible dangers to themselves
POSSIBLE SOLUTIONS
SELLER KNOWS MORE
BUYER KNOWS MORE
Regulation: governments can pass laws and regulation that ensure quality standards and safety features that producers and sellers of goods and services must maintain
Provision of information: Government directly supplying information to consumers
Licensing
PRIVATE RESPONSES
Screening: buyers may try to get more information about what they are buying
eg: finding information on the internet
Signalling: to convince buyers that the product being sold is of good quality
PRIVATE RESPONSES
Private insurance companies usually protect themselves by offering a range of policies where the lower the cost of the insurance, the higher the deductible
GOVERNMENT RESPONSES
require all individuals to participate in a market to reduce adverse selection
provide subsidies to encourage more participation in markets
may directly provide a good or service
enforce information-sharing laws to reduce the knowledge gap
implement community ratings, where prices are averaged across a population rather than based on individual risks
Situation where one party takes risks but does not face the full costs of these risks because the full costs of the risks are borne by other party
RESPONSES
Require individuals to bear part of the cost, even if they are insured
Governments can regulate industries where moral hazard is prevalent to ensure accountability
Tie government support or subsidies to specific behavior or outcomes.
Educate individuals about the long-term consequences of risky behavior.
Reward individuals or organizations for responsible behavior
MARKET POWER
PERFECT COMPETITION
MONOPOLISTIC COMPETITION
OLIGOPOLY
MONOPOLY
very many firms, homogenous, no barrier, price taker, high degree of competition
relatively many firms, differentiated product, no barrier, some control over price, good amount of competition
few large number of firms, differentiated/undifferentiated product, high barrier to entry, significant control over price, some degree of competition
one large firm, one product with close substitute, high barrier to entry, very significant control over price, no competition
CONCEPT
REVENUE CONCEPT
COST CONCEPT
PROFIT CONCEPT
ADDITIONAL CONCEPT
total revenue (TR)
marginal revenue (MR)
average revenue (AR)
total earnings of firm from sale of output
additional revenue arise from sale of additional unit of output
revenue per unit of output
TR = P X Q
MR = ∆ TR / ∆ Q
AR - TR / Q
explicit cost
implicit cost
total costs (TC)
average cost (AC)
marginal cost (MC)
payment made to outsider to buy input
income sacrifice by firm that use as resources
explicit + implicit cost
total cost per unit of output
AC = TC / Q
additional cost arise from produce one additional unit of output
MC = ∆ TC / ∆ Q
profit
normal profit
abnormal profit
negative profit (loss)
profit maximisation
total revenue minus total cost
minimum amount of revenue required for firm to continue running
revenue is greater than normal profit
revenue less than cost
determine level of output that firm produce to make profit as large as possible
TR - TC
TR = TC
TR > TC
TR < TC
1ST = TR & TC 2ND = MR & MC
long run (LR)
short run (SR)
economies of scale
diseconomies of scale
period of time when firms changes all resources
period of time when firm have one resources is fixed
decrease in AC over LR as all resources increase
increase in AC over LR as all resources increase
PROFIT MAXIMISATION
abnormal profit
normal profit
loss
P > AC
P = AC
P < AC
Short run: abnormal profit, normal profit loss
Long run: normal profit
Short run: abnormal profit, normal profit loss
Short run: abnormal profit, normal profit loss
Short run: abnormal profit, normal profit loss
Long run: normal profit
Long run: abnormal profit
Long run: normal profit