Unit 2.7 - Role of Government in Microeconomics

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State the formula: Government subsidy expenditureHL

Government subsidy expenditure = subsidy per unit × quantity sold after subsidy Total government spending on a per-unit subsidy equals the subsidy per unit times the quantity sold after the subsidy is introduced.

State the formula: ShortageHL

Shortage = Q_d - Q_s Quantity shortage when price ceiling is below equilibrium: difference between quantity demanded and quantity supplied at the controlled price.

State the formula: SurplusHL

Surplus = Q_s - Q_d Quantity surplus when price floor is above equilibrium: difference between quantity supplied and quantity demanded at the controlled price.

The situation where individuals benefit from a good or service without paying for it.

free rider problem

State the formula: Per-unit subsidy

Per-unit subsidy = vertical distance between S and S' Graphical representation showing the monetary amount of subsidy per unit as the vertical separation between the original and subsidised supply curves.

State the formula: Total cost of regulation

Total cost of regulation = Σ (required_reduction_i × unit_cost_i) Used to compute the total industry cost of meeting pollution reduction targets by summing each firm's required pollution cut multiplied by that firm's unit cost, as in the worked example.

agricultural subsidies

Financial support provided by the government to farmers to enhance production and maintain food security, often debated for their economic merits and impact on market efficiency.

competitiveness

The ability of firms to effectively compete in the market, which can be enhanced by production cost reductions resulting from subsidies. While this can improve profitability, over-reliance on subsidies may shield inefficiency, distorting competition and creating potential deadweight losses.

economic efficiency

An allocation of resources that maximises welfare in a market. Subsidies and other interventions are typically used to offset market failures in order to achieve greater economic efficiency.

environmental protection

The establishment of regulations and laws by the government to safeguard the environment, including limits on pollution and requirements for pollution-control technologies in various industries.

incidence (of a subsidy or tax)

The distribution of benefits or costs resulting from a subsidy or tax, reflecting how resources are allocated among stakeholders like consumers and producers. With subsidies, consumers enjoy lower prices, while producers experience increased surplus, which may lead to market distortions and opportunity costs.

A situation in which state intervention leaves resources worse allocated than the market would have — through poorly targeted services, weak incentives to control costs, or political objectives driving the decision.HL

government failure

Actions taken to correct market failures and inequities.HL

Government intervention

Programs that require individuals to actively decline participation instead of opting in.HL

automatic enrolment schemes

Small prompts that influence behavior without limiting choice.HL

Nudges are created by choice architects

Opt-outHL

An automatic enrollment system that places individuals into programs, such as pension or organ donation schemes, requiring them to actively choose to withdraw if they do not wish to participate. This approach increases participation rates compared to opt-in systems that require proactive action to join.

consumer behaviourHL

The study of how individuals make decisions about purchasing and using goods and services. It is influenced by immediate feedback on social norms and expectations, highlighting the impact of societal factors on personal choices and behaviors.

opt-out schemeHL

An automatic enrolment system that requires individuals to take action to opt out, rather than to opt in. This approach is used in contexts like pension contributions and organ donation, making participation easier and more likely unless individuals actively choose to exclude themselves.

A regulatory approach where the government specifies what is permitted or required directly.

command and control regulation

The imposition of rules, laws, or standards by the government to affect how consumers and producers behave.

regulation

The situation where the government itself provides a good or service, often at no cost or at a reduced price.

direct provision

When demand exceeds supply due to a price limit.

Shortage

A charge that is a fixed amount per unit sold.

Specific – These taxes

A taxation method where the levy is based on a percentage of the sale price of a product or service.

ad valorem tax

State the formula: Tax revenue

Tax revenue = per unit tax × quantity sold Tax revenue = tax per unit × quantity sold after tax

State the formula: Vertical gap on graph

Vertical gap on graph = value of specific tax On a supply–demand diagram the vertical distance between the original supply curve and the shifted supply curve (or between pre‑ and post‑tax consumer prices) represents the amount of the specific tax per unit.

Specific tax (per unit tax)

A fixed charge imposed on each unit of a good or service sold, a specific tax is calculated per unit rather than based on the product's price. This type of tax results in a leftward shift of the supply curve, leading to higher market prices and a reduction in quantity demanded, impacting overall market equilibrium.

Tax incidence

The distribution of the burden of a tax between consumers and producers, tax incidence depends on the price elasticity of demand and supply. Inelastic demand allows producers to pass a larger portion of the tax to consumers, while elastic demand means producers absorb more of the tax burden.

A government control setting a binding minimum that a product may be sold for, deliberately above the market equilibrium, to protect producers' incomes and encourage supply.

price floor

A legally mandated lowest hourly pay rate that employers must offer to their employees.

National minimum wage (NMW)

A regulatory framework that limits how high a charge can be for specific goods or services, aiming to make them affordable for consumers.

Price ceiling

Regulations implemented by the government to set boundaries on how high or low a charge can be for specific goods and services.

Price controls

Regulations that limit how much housing costs can rise.

Rent controls

The highest allowable charge for a product or service, typically set to prevent costs from rising excessively.

maximum price

The lowest amount a seller can charge for a good, set by the government above the market-clearing level.

minimum price

Deadweight loss

The loss of economic efficiency that occurs when the equilibrium outcome is not achievable or not achieved. Deadweight loss can result from price controls, taxes, or other market distortions that prevent optimal allocation of resources.

Price ceiling (maximum price)

A government-imposed limit on how high a price can be charged for a good or service, set below the market equilibrium price. Price ceilings aim to protect consumers from high prices but can lead to shortages and market distortions.

Price floor (minimum price)

A government regulation that sets a minimum price for a good or service, typically above the market equilibrium price. Price floors are intended to ensure that producers receive a fair price, but they can also lead to surpluses.

Underground/parallel markets

Illegal markets that emerge when price controls, such as price ceilings, create shortages. These markets allow goods to be sold at higher prices than legally permitted, circumventing regulations and often leading to further market distortions.

A classification of levies on income, wealth, or spending.

Taxes

State-owned investment funds that generate income for government expenditure through various assets.

sovereign wealth funds (SWF)

The need for government to borrow when revenue sources fall short.

Public sector borrowing

The process of selling government-owned assets to the private sector.

privatization

Privatization proceeds

The revenue generated from the sale of state-owned enterprises and government assets to the private sector. This source of revenue can provide a significant influx of funds for governments, though it is typically a one-time financial boost.

direct taxes

Taxes that are levied directly on individuals' or entities' income and wealth, as opposed to taxes on goods and services. Direct taxes are a significant component of government revenue and play a role in income redistribution and economic activity.

government revenue

The funds collected by the government from various sources, primarily through taxes, which are essential for financing public services and interventions in the economy. Government revenue is crucial for enabling the government to achieve economic objectives and support welfare initiatives.

Collective consumption items provided by the state that non-payers cannot be excluded from, and where one person's use does not reduce the amount available to anyone else.

public goods

External costs that impact stakeholders who are not part of an economic transaction.

negative externalities

Financial resources allocated for innovation and product development.

Research and development funding

Financial support provided to reduce production costs for local firms.

Subsidies to domestic producers

Financing offered to firms at lower interest rates to support expansion and operations.

Business development loans

Goods that provide positive external benefits to those not directly involved in their transaction.

merit goods

Government intervention to rescue failing businesses crucial to the economy.

Financial bailouts

Standards and regulations that foreign firms must comply with.

Administrative barriers

The use of tax revenues aimed at redistributing income and wealth to enhance equity.

transfer payments

consumer nudges

The practice of subtly influencing consumer choices through small prompts or tweaks, designed by choice architects like the government, to encourage better decision-making without removing freedom of choice.

income redistribution

The process of reallocating income and wealth through government policies, such as progressive taxes and transfer payments, aimed at promoting equity and reducing poverty among low-income households.

nudges (HL)

Subtle policy shifts or incentives designed to influence individuals' behavior in a predictable way without forbidding any options or significantly changing their economic incentives. Nudges aim to improve social welfare by encouraging better decision-making.