Role of government in microeconomics

A legally imposed maximum price set BELOW the equilibrium price, designed to keep the good affordable for consumers. It prevents the market price from rising above a set level.

Any price that is not the equilibrium price means fewer units are traded than at equilibrium. Some mutually beneficial transactions no longer happen — the surplus those trades would have generated is lost. This applies to both ceilings and floors.

A legally imposed minimum price set ABOVE the equilibrium price, designed to protect producers' income. It prevents the market price from falling below a set level.

At the higher price, Qs > Qd → SURPLUS (excess supply). Producers make more than consumers want to buy. The government may have to purchase the surplus to maintain the floor price, which is costly for taxpayers.

If the ceiling is set at or above equilibrium, the market price is already below the ceiling, so there is no binding constraint. Only when the ceiling is below equilibrium does it prevent the price from reaching its natural market level.

1) Effectiveness — does it achieve its goal? 2) Efficiency — what is the deadweight loss? 3) Equity — who gains and who loses? 4) Alternatives — are there better policies (subsidies, vouchers, income transfers)?

Shortages (Qd > Qs), queues and rationing, black markets at illegal higher prices, reduced product quality (producers cut costs), and reduced supply in the long run as firms exit the market.

1) Minimum wage — set above equilibrium wage, it can cause unemployment (surplus of labour). 2) Agricultural price supports (e.g. EU Common Agricultural Policy) — guaranteed minimum prices for farmers that create food surpluses ("butter mountains").

Gains: consumers who can buy at the lower price. Loses: producers (lower price, less revenue), consumers who cannot get the good (shortage), and society (deadweight loss, possible black market activity).

Rent controls — they keep rents low for existing tenants but can lead to housing shortages, reduced maintenance, and long waiting lists. Cities like Stockholm and New York have experienced these problems with rent control policies.

Short run: some consumers/producers benefit from the controlled price. Long run: shortages/surpluses worsen, quality deteriorates, investment falls (ceiling) or overproduction grows (floor), and the market becomes increasingly distorted.

Surpluses (unsold goods or unemployed workers), higher prices for consumers, government cost of buying surplus, inefficient producers kept in business, and overproduction encouraged.

Price ceiling (below equilibrium) → shortage, black markets, lower quality. Price floor (above equilibrium) → surplus, government purchases, overproduction. Both create deadweight loss and reduce allocative efficiency.

The ceiling creates a shortage — people who cannot get the good at the legal price are willing to pay more. Sellers can charge above the ceiling illegally because demand exceeds supply. The black market price is typically above the original equilibrium price.

Subsidies (lower cost without fixing price), vouchers (targeted help for low-income consumers), income transfers (give money directly rather than distorting the market), and taxation (for floor-type goals like reducing demerit good consumption).

How the burden of a tax is shared between consumers and producers. It is determined by the relative elasticities of demand and supply — whichever side is more inelastic bears more of the tax burden.

Consumer surplus decreases (higher price, lower quantity). Producer surplus decreases (lower net price, lower quantity). Government gains tax revenue (tax per unit × Qsold). But there is a deadweight loss — a triangle of lost surplus from reduced output.

A tax imposed on goods and services (not on income), collected by the seller and passed on to the government. It raises the cost of production, shifting the supply curve LEFT (or upward by the amount of the tax).

Specific tax: a fixed amount per unit (e.g. $1 per litre) — supply curve shifts up by a parallel/equal amount. Ad valorem tax: a percentage of the price (e.g. 20% VAT) — supply curve shifts up by an increasing amount (gap widens at higher prices).

The triangular area of lost surplus caused by the tax reducing quantity below the equilibrium level. Some mutually beneficial trades no longer happen because the tax raises the price above what some consumers are willing to pay.

Whoever is more INELASTIC bears more of the tax. Inelastic demand → consumers bear more (they keep buying). Elastic demand → producers bear more (cannot pass it on). Inelastic supply → producers bear more. Elastic supply → consumers bear more.

If it corrects a negative externality (Pigouvian tax), the DWL from the tax may be smaller than the welfare loss from the externality. The tax moves quantity closer to the socially optimal level, actually reducing total welfare loss. It also generates revenue for government services.

Supply shifts left/up → equilibrium price rises and quantity falls. Consumers pay a higher price than before. Producers receive a lower price (net of tax). The gap between consumer price and producer price equals the tax per unit.

Cigarettes have inelastic demand (addiction). When a tax is imposed, producers can pass most of it on to consumers as a higher price because consumers keep buying despite the increase. This is also why cigarette taxes generate enormous revenue.

Show the tax as a vertical gap between S and S+tax. Shade the consumer burden (area between new consumer price and old equilibrium price) and producer burden (area between old equilibrium price and new producer price) in different colours.

Draw S and S+tax (shifted up/left). The vertical gap between the two supply curves equals the tax per unit. New equilibrium at S+tax ∩ D. Mark: consumer price (Pc), producer price (Pp), and tax per unit (Pc − Pp).

They take a larger proportion of income from the poor than the rich. Taxes on essentials (food, energy) hit low-income households hardest because these goods make up a larger share of their spending. This is an important evaluation point in exams.

With elastic demand, consumers are very responsive to price. Producers cannot pass much of the tax on because consumers would stop buying. So producers bear most of the burden — their net price (Pp) falls significantly while the consumer price (Pc) barely rises.

1) Raise revenue for government spending. 2) Reduce consumption of demerit goods (tobacco, alcohol). 3) Correct negative externalities (pollution taxes). 4) Redistribute income (can target luxury goods via ad valorem rates).

Consider: (1) Revenue raised vs deadweight loss. (2) Effectiveness at reducing consumption (depends on PED). (3) Regressive effects on low-income groups. (4) Whether it corrects an externality. (5) Administrative costs and enforcement challenges.

The more inelastic side gets LESS of the subsidy benefit. Inelastic demand → consumers benefit less (price does not fall much). Elastic demand → consumers benefit more (price falls significantly). This mirrors the tax incidence rule in reverse.

A payment by the government to producers to reduce costs, encourage production, or lower prices for consumers. It shifts the supply curve RIGHT (or downward by the amount of the subsidy) — the opposite of a tax.

1) Lower prices for consumers on essential goods. 2) Higher output and employment. 3) Can correct market failure (increase merit goods/positive externalities). 4) Can protect strategic or infant industries from foreign competition.

Mainly producers. With inelastic demand, price barely falls (consumers are not very responsive), so producers capture most of the subsidy as higher revenue. The consumer price drops only slightly despite the government spending.

Supply shifts right/down → equilibrium price FALLS and quantity RISES. Consumers pay a lower price. Producers receive a higher effective price (market price + subsidy per unit). Government pays the total cost: subsidy per unit × quantity.

Government money spent on subsidies could be used for schools, hospitals, infrastructure, or debt repayment. Every subsidy has an alternative use. In evaluation, always ask: "Is this the best use of taxpayer money?"

They keep inefficient producers in business (no incentive to improve), can lead to overproduction and surpluses (EU butter mountains), and create dependency — once introduced, subsidies are politically difficult to remove.

They are exact opposites. Tax: S shifts left/up → P↑, Q↓. Subsidy: S shifts right/down → P↓, Q↑. Both affect the gap between consumer and producer price, but in opposite directions. Incidence rules also mirror each other.

Mainly consumers. With elastic demand, consumers are very responsive to price, so the price falls significantly and quantity rises a lot. Most of the subsidy benefit reaches consumers through lower prices.

If the benefit goes to producers (when demand is inelastic), consumers — who may be the target group — see little price reduction. Also, subsidies may be captured by middlemen, or producers may not pass on cost savings to consumers.

Total government cost = subsidy per unit × quantity sold after subsidy. On a diagram, this is the rectangle formed by the subsidy per unit (vertical gap between S and S−subsidy) multiplied by the new equilibrium quantity.

Producers become dependent on the subsidy and lobby politically to keep it. Consumers get used to lower prices. Removing the subsidy causes price rises and job losses — politically unpopular even if economically efficient.

Discuss advantages (lower prices, correct market failure, support employment). Then disadvantages (opportunity cost, market distortion, overproduction, dependency, may not reach intended recipients). Balance with: "It depends on the elasticity, the size of the externality, and the opportunity cost."

1) Make essential goods affordable (food, education, healthcare). 2) Correct positive externalities (vaccines, renewable energy). 3) Support domestic producers (agriculture, infant industries). 4) Encourage merit goods that society believes are under-consumed.

Governments subsidise renewable energy installation (e.g. solar panels). The subsidy lowers the cost to households, increasing adoption. This corrects the under-consumption because the external benefit (lower carbon emissions) was not reflected in the market price.