Government microeconomic intervention (AS)

3.1 Reasons for government intervention in markets

Markets can fail to allocate resources efficiently or fairly, so governments intervene to:

Intervention can address the non-provision of public goods (the state provides them from taxes), the over-consumption of demerit goods (tax, ban or inform) and the under-consumption of merit goods (subsidise, provide directly or make compulsory).

3.2 Methods and effects of government intervention in markets

Indirect taxes

An indirect tax (VAT, excise duty) is levied on spending. A specific tax is a fixed amount per unit; an ad valorem tax is a percentage. A tax shifts the supply curve left (up by the tax). The price rises, quantity falls, and the tax burden is shared between consumers and producers.

Reasons for taxing: raise revenue, reduce consumption of demerit goods, internalise externalities. Limits: regressive effects on the poor, black markets, difficulty setting the right rate.

Subsidies

A subsidy is a payment to producers that lowers costs; the supply curve shifts right (down by the subsidy), price falls and quantity rises. Used to encourage merit goods and positive externalities, support new industries and farmers. Costs: opportunity cost to the government, may keep inefficient firms going, hard to withdraw.

Price controls

Other methods

• Regulation: laws that ban or limit activities (pollution limits, safety, age limits) and competition law. Needs monitoring and enforcement.
• Direct provision: the government supplies goods (education, healthcare, roads) funded by taxes; avoids under-provision but has opportunity costs and may lack efficiency.
• Information provision: campaigns, labelling, to correct information failure.
• Tradable permits: a cap on pollution; firms buy and sell permits.
• Nationalisation and privatisation.

Evaluating intervention

Government failure occurs when intervention worsens the allocation: poor information, unintended consequences, administration costs, political motives, regulatory capture. A policy's success depends on elasticities, time lags, costs and benefits and side effects.

Buffer stock schemes stabilise the price of a commodity (such as wheat or coffee) whose price swings with the weather. The authority sets a minimum (floor) price and a maximum (ceiling) price: in a good harvest, when the price would fall below the floor, it buys the surplus and stores it; in a poor harvest, when the price would exceed the ceiling, it sells from its stock. This stabilises farmers' incomes but costs money to store and run, can be hard to set the right prices and may encourage over-production. Production quotas limit how much each producer may supply to raise price or limit damage (for example in fishing), but can lead to cheating, black markets and higher prices for consumers. Excessive administrative burdens ("red tape") are a government failure that raises firms' costs.

3.3 Addressing income and wealth inequality

Income is a flow received over time; wealth is a stock of assets. Inequality exists within and between countries. The Lorenz curve shows the share of income going to each cumulative share of the population; the further the curve from the line of equality, the greater the inequality. The Gini coefficient is the ratio of the area between the Lorenz curve and the line of equality to the whole area under the line: 0 = perfect equality, 1 = perfect inequality.

Causes of inequality

Differences in skills, education and wages, unemployment, ownership of assets, inheritance, discrimination, age, regional differences, and the tax and benefit system.

Taxation

Policies to reduce inequality

Progressive taxation, transfer payments (benefits, pensions), a minimum wage, free or subsidised education and healthcare, investment in skills, and inheritance taxes.

Evaluation: high taxes may reduce incentives to work and invest, benefits can create a poverty trap and cost money, and equity and efficiency may conflict. Value judgements affect how much inequality is acceptable. Equity is fairness; equality is sameness.

State provision of essential goods and services (education, healthcare, housing) lets low-income households have them regardless of ability to pay, which narrows inequality of outcomes and opportunities, but costs taxes and may be inefficient. A negative income tax pays benefits to people below an income threshold, falling as their earnings rise (rather than taxing them), which supports the poor while keeping an incentive to work.