AS Micro

Government Intervention in Markets

Taxes

Indirect taxes on producers (affecting supply) Indirect taxes on consumers (affecting demand)

Subsidies

Subsidies to consumers Subsidies to producers Guaranteed minimum prices to producers

Price controls

Minimum wages Price capping / ceilings (i.e. maximum prices) Buffer stock agency schemes

Regulation

Prohibition of sale Minimum legal ages for consumption State ownership of businesses (nationalisation)

Buffer Stocks Do They Work?

How might a buffer stock help to stabilise prices in the cocoa market?
Price of Cocoa

Planned Supply

Upper Target

Upper Target Price

Lower Target Market Demand

Lower Target Price

Quantity

A rise in market supply

Price of Cocoa Actual Supply

Planned Supply

Upper Target

Upper Target Price

Lower Target Market Demand S1

Lower Target Price

Quantity

A rise in market supply

Price of Cocoa Actual Supply

Planned Supply

Upper Target

Upper Target Price

Lower Target Market Demand S1

Lower Target Price

Quantity

A rise in market supply

Price of Cocoa Actual Supply

Planned Supply

Upper Target

Upper Target Price

Lower Target Excess supply at this price Q1 S1 Market Demand

Lower Target Price

Quantity

A rise in market supply

Price of Cocoa
Demand with purchases

Actual Supply

Planned Supply

Upper Target

Upper Target Price

Lower Target Market Demand Q1 S1

Lower Target Price

Quantity

A rise in market supply

Price of Cocoa
Demand with purchases

Actual Supply

Planned Supply

Upper Target

Upper Target Price

Lower Target Cost of buying up stocks Q1 S1 Market Demand

Lower Target Price

Quantity

The case for price stabilisation

Lower risk of food poverty More stable incomes and profits for farmers Macroeconomic stability Buffer stock ought to be self-financing

Limitations of buffer stock schemes

Buffer may not be large enough to change price

High intervention price leads to rising surpluses

Costs of storage and falling quality of product Might be better long run measures for farmers

Welfare Effects of a Tax and a Subsidy

Costs and Benefits Supply post tax

Supply pre tax A

Demand

Output

Welfare Effects of a Tax and a Subsidy

Costs and Benefits Supply post tax

Consumer B pays B A Supplier receives C C

Supply pre tax

Demand

Output

Welfare Effects of a Tax and a Subsidy

Costs and Benefits Supply post tax

Consumer B pays B A Supplier receives C C

Supply pre tax

Tax revenue Demand

Output

Welfare Effects of a Tax and a Subsidy

Costs and Benefits Supply post tax

Consumer B pays B A Supplier receives C C

Supply pre tax

Tax revenue Demand

Output

Welfare Effects of a Tax and a Subsidy

Costs and Benefits Consumer burden Supply post tax

Consumer B pays B A Supplier receives C C

Supply pre tax

Tax revenue Demand

Output

Welfare Effects of a Tax and a Subsidy

Costs and Benefits Consumer burden Supply post tax

Consumer B pays B A Supplier receives C C

Supply pre tax

Tax revenue Demand

Output

Welfare Effects of a Tax and a Subsidy

Costs and Benefits Consumer burden Supply post tax

Consumer B pays B A Supplier receives C C

Supply pre tax

Tax revenue Demand

B Producer burden

Output

Quick Test!
An indirect tax on the production of a good will have no effect on price if the price elasticity of demand is? _________ If elasticity of demand for a product is (-) 0.4 then the majority of the burden of a tax on the producer will be paid by the _________________

In the event of a new tax on a product, the price will rise by the full amount of the tax when the price elasticity of demand is ___________

Quick Test!
An indirect tax on the production of a good will have no effect on price if the price elasticity of demand is? _________

Quick Test!
An indirect tax on the production of a good will have no effect on price if the price elasticity of demand is? Infinity

Quick Test!
An indirect tax on the production of a good will have no effect on price if the price elasticity of demand is? Infinity If elasticity of demand for a product is (-) 0.4 then the majority of the burden of a tax on the producer will be paid by the

Quick Test!
An indirect tax on the production of a good will have no effect on price if the price elasticity of demand is? Infinity If elasticity of demand for a product is (-) 0.4 then the majority of the burden of a tax on the producer will be paid by the Consumer

Quick Test!
An indirect tax on the production of a good will have no effect on price if the price elasticity of demand is? Infinity If elasticity of demand for a product is (-) 0.4 then the majority of the burden of a tax on the producer will be paid by the Consumer

In the event of a new tax on a product, the price will rise by the full amount of the tax when the price elasticity of demand is ___________

Quick Test!
An indirect tax on the production of a good will have no effect on price if the price elasticity of demand is? Infinity If elasticity of demand for a product is (-) 0.4 then the majority of the burden of a tax on the producer will be paid by the Consumer

In the event of a new tax on a product, the price will rise by the full amount of the tax when the price elasticity of demand is ZERO

Welfare effects of a subsidy

Costs and Benefits

Supply pre subsidy

Supply post subsidy

Demand B Output

Welfare effects of a subsidy

Costs and Benefits

Supply pre subsidy

A
C

Supply post subsidy

Demand B D Output

Welfare effects of a subsidy

Costs and Benefits Supplier E receives C

Supply pre subsidy

A
Consumer C pays B

Supply post subsidy

Demand B D Output

Welfare effects of a subsidy

Costs and Benefits Supplier E receives C

Supply pre subsidy

A
Consumer C pays B

Supply post subsidy

Subsidy payment Demand B D Output

A subsidy when demand is price elastic

Price Supply pre subsidy

A Supply post subsidy

Demand

Output

A subsidy when demand is price elastic

Price Supply pre subsidy

A Supply post subsidy

D
Demand

Output

A subsidy when demand is price elastic

Price E Supply pre subsidy

A Supply post subsidy

D
Demand

Output

A subsidy when demand is price elastic

Price E Supply pre subsidy

A Supply post subsidy

D
Demand

Output

A subsidy when demand is price elastic

Price E Supply pre subsidy

A Supply post subsidy

D
Demand

Elastic demand so a subsidy causes a large rise in quantity demanded

B C Output