Government Intervention

The main forms of government intervention discussed are:

• Taxation
• Subsidies
• Price controls

Taxation

An indirect tax increases production costs and shifts the supply curve upward by the amount of the tax.

Tax with Elastic Demand

When demand is elastic:

• Quantity demanded falls significantly.
• Government tax revenue is relatively lower.
• Producers bear a larger share of the tax burden.
• Consumers bear a smaller share of the tax burden.

Tax with Inelastic Demand

When demand is inelastic:

• Quantity demanded falls only slightly.
• Government tax revenue is relatively higher.
• Consumers bear a larger share of the tax burden.
• Producers bear a smaller share of the tax burden.

Subsidies

A subsidy reduces the per-unit cost of production and shifts the supply curve downward.

Subsidy with Elastic Demand

When demand is elastic:

• Quantity demanded increases significantly.
• Producers receive a larger share of the subsidy benefit.
• Consumers receive a smaller share through a lower price.

Subsidy with Inelastic Demand

When demand is inelastic:

• Quantity demanded changes only slightly.
• Consumers receive a larger share of the subsidy benefit.
• Producers receive a smaller share of the benefit.

Price Controls

Price controls are government restrictions on market prices.

Price Floor

A price floor is a minimum price set above the equilibrium price.

Its purpose is to protect producers.

Examples:

• Minimum wage
• Agricultural price supports

Effects:

• Price is kept above equilibrium.
• Quantity supplied increases.
• Quantity demanded decreases.
• A surplus is created.

Price Ceiling

A price ceiling is a maximum price set below the equilibrium price.

Its purpose is to protect consumers from high prices.

Examples:

• Rent controls
• Price caps on essential goods

Effects:

• Price is kept below equilibrium.
• Quantity demanded increases.
• Quantity supplied decreases.
• A shortage is created.

Summary