4.

Government Microeconomics Intervention

When are markets unable to satisfy important economic objectives? And

does government intervention help?
 The market mechanism may result in socially undesirable outcomes that
do not achieve efficiency, environmental sustainability and or equity.

 Market failure, resulting in allocative inefficiency and welfare lose.

 Resource overuse, resulting in challenges to environmental sustainability.

 Inequity resulting in inequalities.

 Governments have policy tools which can affect market outcomes, and
government intervention is effective, to varying degrees, in different real
world markets.
 4.1 Why do the governments intervene in
markets?

The government intervenes in markets when the

market is unable to satisfy important economic
objectives.
 1. When markets fail:
 Market failure is the inability of the market to achieve allocative efficiency.
 It may result due to the existence of negative or positive effects imposed on
3rd parties arising from production and consumption.
 There could be an overproduction or underproduction of particular goods.
 Government intervention might help promote more desirable levels of
production that increase overall social welfare.

2. When sustainability is threatened:

 Resources are sometimes being overused in markets.
 A system is sustainable when it is able to endure in its current form
indefinitely for generation after generation.
 Markets often exploit non renewable resources in the present at a rate that
depletes them faster than they can be replenished.
 When resources are overused today, they will be unavailable for future
generations. Hence the system under which they are exploited becomes
unsustainable.
 3. To fund government:
 To finance the functioning of the government, some degree of intervention in
the market is necessary.
 Taxes on income, production and consumption helps generate the revenues
necessary for the government system to function.
 Thus, intervention in markets is a necessary condition for the very existence
of government

4. To promote equity:
 Governments may also intervene in the market to support firms or
households through subsidies or transfers.
 It can influence both the level of production and consumption in the market
to correct market failure or to promote equity.
 How do the governments intervene in markets?
The following forms of government intervention are taken at the
microeconomic level:

 Price control
 Indirect taxes
 Subsidies
 Direct provision of services
 Command and control regulations and legislations
 4.2 Price Control

 In a free market prices are determined by the forces of demand and supply.

 Price control refers to government setting and maintaining the price above
or below the equilibrium level that was determined by demand and supply.

 It results to market disequilibrium hence, shortages or surplus being

created.
 Price ceiling (maximum price):
• price ceiling is a maximum price imposed by the government below the
equilibrium price in a market.

• In this market situation, the government determines that there is a

potential for higher than desired prices, and makes a goal to keep prices
low.

• The propose for this measure by the government is to make basic goods
and services affordable to low income households.
 Let’s assume the market for bread in
France:
• Assuming that the French government
wishes to keep bread affordable and
imposes a price of €2 per loaf.
• Let’s also assume that without
government intervention the equilibrium
price would be €3 as shown on the
diagram below.
 The imposition of a ceiling price
Pc= €2 has led to a greater
quantity demanded (8 million) and
a smaller quantity supplied (4
million)
 The lower price imposed by the
government has send signals to
French consumers of bread to
demand more bread and to the
bakers to bake fewer loaves.
 Effects of ceiling price
The consequences for the economy include:
1. Shortages: With a binding price ceiling (i.e. one that is actually below the
equilibrium price) producers will reduce output while consumers demand
more, creating a shortage in which there is excess demand for the
product.

2. Non price rationing: rationing refers to a method of dividing up

something amongst possible users. With the ceiling price, the quantity
supplied, which is lesser than the quantity demanded can be distributed
amongst the interested buyers through the non-price rationing method
which include
- those who come first will be serve
- favoritism, where the sellers sell to those they prefer.
- distribution of ration cards to interested buyers so that they can
purchase a fixed amount of good in a given time period.
3. Underground markets (parallel markets):
- The disequilibrium created by a price ceiling puts pressure on sellers to
withhold their output from the formal market and instead sell it on the
informal or black market.

- Whenever there is an imbalance between the quantity demanded of a good

and the quantity supplied, sellers will turn to the black market to meet the
excess demand by selling their product at a higher price than the
government’s ceiling price..

- This undermines the validity of the price control's intended outcome.

4. Under allocation of resources to
the good and allocative inefficiency:
there are too few resources allocated to
the production of the good, resulting in
underproduction relative to the social
optimum (or ‘best’). Society is worse off
due to under allocation of resources
and allocative.

5. Negative welfare impacts: welfare

loss (deadweight loss), or lost of social
benefits due to the price ceiling.
Welfare loss represents benefits that
are lost to society because of resource
misallocation.
 Consequences for various stakeholders:
1. Consumers: Consumers partly gain and partly lose. They lose area b but
gain area c from producers. Those consumers who are able to buy the good at
the lower price are better off. However, some consumers remain unsatisfied
as at the ceiling price there is not enough of the good to satisfy all demanders.

2. Producers: Producers are worse off, because with the price ceiling they sell
a smaller quantity of the good at a lower price; therefore, their revenues drop.
This is clear also from their loss of some producer surplus, (which is
transferred to consumers), as well as welfare loss.
3. Workers: The fall in output (from Qe to Qs) means that some workers are
likely to be fi red, resulting in unemployment; clearly these workers will be
worse off.

4. Government: There will be no gains or losses for the government budget,

yet the government may gain in political popularity among the consumers who
are better off due to the price ceiling.