Business Environment-Economics

National Diploma in Accounting

Level 5- 1st Semester
2.4 Impact of Government Intervention

When looking at market equilibrium from a social and political point of view some believe market
equilibrium is as unfavorable to the society.

Because of this reason the government intervenes to the market in various ways

The main ways of government intervention are as follows.

 Imposing of taxes

 Providing of subsidies

 Price control

 Price stabilization

Imposing of taxes

Imposing taxes on consumers and producers can be considered as a common situation of government
intervention to the market process.

There are two forms of the taxes imposed on goods and services.

 Proportional tax or ad-valorem tax

Imposing a particular percentage of a tax based on the value of product produced or consumed is known
as ad-valorem tax.

Example: 2% tax on the value of 1 Kg. of sugar

 Specific tax or unit tax

Imposing taxes on a unit of a product produced or consumed is known as a unit tax or as a specific tax.
Example.

Imposing of Rs. 10tax per one Kilogram of sugar.

Imposing of Rs. 2tax per loaf of bread

When imposing taxes on supplier, the cost of production increases. As a result supply decreases and the
supply curve shift to left side by the same amount of tax

Following is a demand and supply schedule of a certain goods at a competitive market.

Price (Rs.) Quantity supplied

0 0

5 10

10 20

15 30

20 40

25 50

30 60

35 70

40 80

Think that the government imposes an Rs 5 unit tax for this good. Because of this new market supply
schedule can be shown as follows.
Providing of subsidies…..
After providing a unit subsidy, the influence on market equilibrium can be shown with a supply
schedule, supply curve and supply equation is shown below.
Demand and supply schedules relevant to a particular good sells at a competitive market is given
below.

Assume that the government is providing Rs. 5subsidy over each unit of this good. The new supply
schedule after providing the subsidy is as fallows. Qd= 80-2P Qd= 0+2P
Due to providing of a unit subsidy supply curve shifts to the right from 134 S to S1 by the amount
of unit subsidy.
Equilibrium before the subsidy Equilibrium after the subsidy
Equilibrium Price = Rs. 20 Equilibrium Price = Rs. 17.50
Equilibrium quantity = unit 40 Equilibrium quantity = unit 45
Welfare effects of the unit subsidy
Keep one page here
The effects of price control on market operations.
 The prices of goods or services which determined by the forces of demand and supply
would not be fair to consumers and producers.
 In this situations government control the market price.
 The price control is creating of an artificial price at the market by the government using
rule and regulations.
 Government aim is to protect producers and consumers by the price control.
 There are two types of price control.
1. Maximum price – ceiling price
2. Minimum price – floor price
Maximum price
When the government think that market equilibrium is unfair for consumers to give them fairness
the legal price decided by the government is called maximum price.
It is better to implement the maximum price lower the equilibrium price as the aim of deciding
maximum price is to provide fairness for the consumers.
Such maximum price decided lower the equilibrium price is called as an effective maximum price.
Examples: implementing maximum price for Rice, Bread, Sugar and Dhal, Deciding of maximum
rent for houses.
Following graph presents such an effective maximum price control.

Because of the maximum price control, the quantity demand increase from Q to Q1 and quantity
supplied decrease from Q to Q2. 
As a result of this, there is an excess demand of Q1 – Q2 is created with in the market.
Similarly, producers tend to sell the supply Q2 at price P2 which is called black market price.
Effects of maximum price can be further presented as below.
Creation of shortage of goods, due to the excess demand.
Attempt to sell goods at an illegal black market price,
Because of the black market price, selling of goods at a price more than the previous price.
Due to the maximum price as consumer surplus and producer surplus are adversely affected it will
also badly affects social welfare.
The effect of consumer and producer surplus and effect over welfare can be illustrated by a graph
as follows

(i) Consumer surplus before maximum price ceiling = A+ B + C

(ii) Producer surplus before maximum price ceiling = D + E + F
(iii) Economic surplus before maximum price ceiling = A + B + C + D + E + F
(iv) Consumer surplus after price ceiling = A (lost of B + C)
(v) Producer surplus after price ceiling = F
(vi) Economic surplus after price ceiling = A + F
(vii) Dead weight loss = C + E
Maximum price
Maximum price is meaningful only if consumer received expected benefit as it is.  There
are several approaches that can be taken to make maximum price meaningful.
1. Import
2. Providing incentives for the producers
3. Rationing i,dl lsÍu
Goods can be imported as a remedy to the shortage of the goods arise due to the excess
demand created by the maximum price. By doing so the benefit of imposing a maximum
price can be given to the consumer.
 Similarly by taking actions to encourage the producers who discouraged by the maximum
price and by preventing market distortions the expected benefit has to be rationed among
consumers.
As the price mechanism being neutralized due to the maximum price policy scare, goods
have to be rationed by using non price rationing techniques. Non price rationing techniques
are as follows.  Use of ration cards
 Queuing method
 Rationing with bribes
 Distribute connecting with other goods
 Black market price
Implementing minimum price control
Minimum price should be imposed higher than the equilibrium price as the aim of the minimum
price is to give fairness for producers.
The minimum price which implement higher than the equilibrium price is called efficiency
minimum price.
Example: Implementing a minimum price for paddy implementing minimum wage rates.
Minimum price implementation can be illustrated with the following diagram.

Effects of minimum price policy can be further illustrated as follows.

1. Accumulation of excess production of the market.
2. Unemployment problems can occur
3. Goods can be supplied to consumers at a discounted rate by keeping minimum price as nominal
price. Sellers try escape from the law.
4. Excess investment situation can be occurred.
5. Affect over social welfare due to the effects over consumer surplus and producer surplus.
Welfare effects of minimum price policy can be illustrated with the following diagram.

Although the minimum price is implemented to give benefits to producers it will not provide
expected benefit to them.
Therefore, to implement minimum price meaningfully soma actions have to be taken. Following
are some of such actions
1. Storing of excess supply
2. by products
3. Promoting the current demand
4. Exports
Activity which the government use to implement minimum price meaningfully is known as price
supporting policy.
In price supporting policies it is certified that the minimum price will be received by the producer.
With considering minimum price as a certified price there are two forms of price supporting
policies which followed by the government to increase producers’ income while protecting them;
1. Price supporting government purchases
2. Deficiency payment system
Stabilization of price
Frequent fluctuations of the prices of the goods produced is considered as price instability. When
prices are unstable it will also occurs instabilities in the incomes of producers.
Fluctuations of the prices of agricultural goods can be commonly seen in the world today. Frequent
fluctuations of prices of agricultural goods became a major problem due to income of farmers
being unstable.
In such situations to stabilize income of cultivators government follows various price stabilization
policies.
Impose of rations over producers, accumulation of stock and distribution, limiting of the lands
cultivated, impose of tariffs over imports, rationing of imports, limit imports, limit import as
desired are some of the price stabilization techniques followed.
Impose of rations over producers is an important price stabilization technique. Impose of a
maximum limit by the government over the amount of goods produced within a particular period
of time is called rationing of products,
By this, it is expected to maintain price at a high level by limiting the supply which reach the
market