2.7 Role of Government In Microeconomics (DP IB Economics: SL): Flashcards
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Define mixed economy.
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Define mixed economy.
A mixed economy is an economy that has varying degrees of government intervention.
What are the four most common methods used to intervene in markets?
The four most common methods used to intervene in markets are indirect taxation, subsidies, maximum prices, and minimum prices.
True or False?
In maximising their self-interest, firms and consumers will self-correct a misallocation of resources.
False.
Firms and consumers maximising their self-interest will not self-correct the misallocation, which is why there is a role for government intervention.
Define market failure.
Market failure occurs when there is a less-than-optimal allocation of resources from society's point of view.
The government has attempted to address tobacco consumption, a form of market failure, by using indirect taxes to consumption.
The government has attempted to address tobacco consumption, a form of market failure, by using indirect taxes to reduce consumption.
How do governments raise revenue through intervention?
Governments raise revenue through intervention such as taxation, privatisation, the sale of licences (e.g. 5G), and the sale of goods and services.
Define equity.
Equity is a normative concept concerned with reducing the opportunity gap between the rich and the poor.
Give two ways governments promote equity.
Governments promote equity through laws such as minimum wage laws, health and safety laws, laws to prevent monopolies, and laws to prevent environmental damage.
True or False?
Governments may limit foreign competition until new domestic firms are well established and able to compete internationally.
True.
Governments support key industries by limiting foreign competition until new firms can compete internationally, alongside providing subsidies or tax breaks.
Governments can support key industries by providing to help them remain competitive.
Governments can support key industries by providing subsidies or tax breaks to help them remain competitive.
How do governments support poorer households?
Governments support poorer households through redistribution policies such as progressive tax structures and welfare payments.
Define indirect tax.
An indirect tax is a tax paid on the consumption of goods or services, and is only paid if consumers make a purchase.
On whom does the government levy an indirect tax?
The government levies an indirect tax on producers, which is why the supply curve shifts to the left.
Define specific tax.
A specific tax is a fixed tax per unit of output, such as $3.25 per packet of cigarettes.
For an inelastic product such as cigarettes, producers pass on a proportion of the indirect tax to consumers.
For an inelastic product such as cigarettes, producers pass on a higher proportion of the indirect tax to consumers.
Define ad valorem tax.
An ad valorem tax is an indirect tax charged as a percentage of the purchase price, such as VAT of 19% in Colombia in 2022.
True or False?
An indirect tax is equally effective at reducing consumption of all demerit goods.
False.
The effectiveness of the tax depends on the price elasticity of demand (PED); where demand is price inelastic, many consumers continue to purchase the good.
Why might an indirect tax lead to the creation of illegal markets?
An indirect tax might create illegal markets because consumers seek to avoid paying the taxes.
Define producer subsidy.
A producer subsidy is a per unit amount of money given to a firm by the government to increase production or the provision of a merit good.
What effect does a subsidy have on market price and quantity demanded?
A subsidy lowers the price and increases the quantity demanded in the market.
True or False?
With a subsidy, the producer benefit is the top portion of the incidence area and the consumer incidence is below.
True.
Unlike an indirect tax, with a subsidy the producer benefit is the top portion and the consumer incidence is below.
Subsidies can distort the of resources in markets, for example causing excess supply in agricultural markets.
Subsidies can distort the allocation of resources in markets, for example causing excess supply in agricultural markets.
What is the opportunity cost of a government subsidy?
The opportunity cost of a government subsidy is that the money could have been used elsewhere.
Define price ceiling.
A price ceiling (maximum price) is set by the government below the existing free market equilibrium price, and sellers cannot legally sell the good or service at a higher price.
Which group do governments typically use a price ceiling to help?
Governments typically use a price ceiling in order to help consumers.
True or False?
A price ceiling creates a condition of excess supply.
False.
A price ceiling is set below the free market price, creating a condition of excess demand (a shortage).
A price ceiling reduces the incentive to supply, so there is a in quantity supplied.
A price ceiling reduces the incentive to supply, so there is a contraction in quantity supplied.
Define price controls.
Price controls are used by governments to influence the levels of production or consumption.
What type of market does the unmet demand from a price ceiling often encourage?
The unmet demand from a price ceiling often encourages the creation of illegal markets (black or grey markets) as desperate buyers turn to illegal bidding.
Define price floor.
A price floor (minimum price) is set by the government above the existing free market equilibrium price, and sellers cannot legally sell the good or service at a lower price.
Why do governments impose a price floor?
Governments impose a price floor to help producers or to decrease consumption of a demerit good such as alcohol.
True or False?
A price floor set above equilibrium creates a condition of excess supply.
True.
The higher price causes an extension in quantity supplied and a contraction in quantity demanded, creating excess supply (a surplus).
In agricultural markets, governments will often purchase the and store it or export it.
In agricultural markets, governments will often purchase the excess supply and store it or export it.
What is one risk to farmers of using price floors in agricultural markets?
Farmers may become over-dependent on the government's help.
Define national minimum wage.
A national minimum wage (NMW) is a legally imposed wage level, set above the market rate, that employers must pay their workers.
What is the effect of a national minimum wage on the labour market?
A national minimum wage set above the market rate causes an excess supply of labour and the potential for unemployment.
True or False?
A minimum wage can never cause unemployment.
False.
If firms are unable to raise their prices, a minimum wage may force them to lay off some workers, increasing unemployment.
A minimum wage raises the for firms, who may respond by raising the price of goods or services.
A minimum wage raises the costs of production for firms, who may respond by raising the price of goods or services.
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