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GOVERNMENT INTERVENTION
Intervention works to change market outcomes and has varying degree of effectiveness in a real-
world situations.
 W H AT A R E T H E S E
REAL-WORLD
S I T U AT I O N S ?

• Market Failure: where the market

fails to achieve allocative efficiency
thus resulting in welfare loss.
• Overuse of resources that challenges
environmental sustainability
• Inequity that results in inequality
 GOVERNMENT INTERVENTION AT
MICROECONOMIC LEVEL
• Price controls: Price ceiling & floor
• Indirect taxes
• Subsidies
• Direct provision of services
• Regulation & legislation
• Consumer nudges
 PRICE CONTROL: PRICE CEILING

Rent control Food price controls

• Maximum legal rent on housing Price controls in Vietnam in 2010

• Below the price determined by the Due to high rates of inflation the
forces of demand & supply Vietnamese government considered
• To make housing more affordable imposition of price controls.
to low-income earners Price ceiling on chemical fertilizers,
milk powder, rice, sugar, animal
feeds, coal, cement, paper etc.
FOOD FOR THOUGHT
 PRICE
CONTROL:
PRICE
FLOOR-
MINIMUM
WAGE &
INCOME
SUPPORT
FOR
FARMERS
 ECONOMIC ANALYSIS
Price Ceiling: Rent control Price Floor: Minimum wage

• Creates shortages – As fixed price is below the price • Creates surpluses: As fixed price is above the price
determined by the market it incentivizes consumers determined by the market it incentivizes suppliers to
to demand more. supply more though demand reduces.
• The system of price rationing fails: Those who are • Burden on government budget: The government
able to pay the price decided by market can buy will have to dispose the surplus either by storing
fails as now non-price rationing methods will work: (involves extra cost) or exporting (granting a
waiting in line, first come first serve, favoritism. subsidy)
• Creation of underground markets: Buying and • Productive inefficiency: Firms having high cost of
selling of transactions go unrecorded when there is production do not even try to put any effort to
a shortage reduce cost as the price fixed is higher, they are able
• Allocative inefficiency: under-allocation of to compete, leading to inefficiency.
resources: Due to government fixing a lower price, • Allocative inefficiency: Too many resources are
suppliers/producers are disincentivized. allocated due to government fixing a higher price.
• Welfare loss: A deadweight loss is created in regard • Welfare loss: A deadweight loss is created in regard
to the loss of social surplus or welfare benefits to loss of social surplus due to government using
budget to buy the surplus.
HOW DOES BOTH WORK GRAPHICALLY?
 STAKEHOLDER ANALYSIS
Stakeholder Price Ceiling Price Floor
Consumer Partly gain and partly lose, who buy at a lower Are worse off by paying higher prices as
price are better off, those who can't buy due to compared to the equilibrium prices
shortage created are worse off

Producer Are worse off, as the price fixed by the Are better off as they receive a higher
government is below the equilibrium price, they price as compared to the market price
are disincentivized to produce more

Workers Are worse off, as production reduces, there is a Are better off, due to more job
chance that a few workers will be fired opportunities as production increase as
producers are incentivized

Government No gain or loss, only political popularity within Burden on government budget as they
consumers buy surplus created due to price floor
and there is also cost of storage.

Causes global misallocation of

resources, as surplus is disposed- off as
exports though at lower price than the
global prices
 GRAPH
FOR PRICE
CEILING
 GRAPH
FOR PRICE
FLOOR
EVALUATION PRICE CEILING: POSITIVES
Affordability: Price ceilings can make essential goods and services more
affordable for low-income consumers, ensuring that even those with
limited means can access necessities like food, housing, or healthcare.

Reduced Income Inequality: By limiting the prices of basic necessities,

price ceilings can reduce the income gap between the wealthy and the less
fortunate, promoting a fairer distribution of resources.
 EVALUATION PRICE CEILING: POSITIVES
Consumer Protection: Price ceilings protect consumers from excessive price gouging
during emergencies or market failures, preventing unscrupulous sellers from taking
advantage of desperate situations.

Stability: They provide stability and predictability in the prices of basic goods, helping
households budget and plan their finances more effectively.

Social Welfare: In some cases, price ceilings can contribute to social welfare by ensuring
access to critical goods and services, improving overall public health, and reducing
poverty rates.
EVALUATION PRICE CEILING: NEGATIVES
Inefficient Allocation: Price ceilings can lead to an inefficient allocation of resources. For
instance, rent control can discourage property owners from investing in property
maintenance or construction, leading to housing shortages and deteriorating conditions.
Market Distortions: They can distort market dynamics and discourage investment and
innovation in industries subject to controls, potentially hindering economic growth and
development.
Administrative Costs: Enforcing and monitoring price ceilings can be administratively
costly for governments.
Rent Seeking: Price ceilings can create incentives for rent-seeking behaviour, where
individuals or companies expend resources to secure controlled goods or services,
exacerbating inefficiencies.
 EVALUATION PRICE FLOOR: POSITIVES
Income Support for Producers: Price floors can provide a safety net for producers by ensuring they
receive a minimum income for their goods, which can be especially important for small farmers
and agricultural producers. This income stability can help maintain the livelihoods of those in the
industry.

Market Stability: Price floors can prevent extreme price fluctuations that might otherwise occur in
volatile markets, providing stability for both producers and consumers.

Quality Assurance: Price floors may encourage producers to maintain higher quality standards
because they can command a higher price for their goods.

Incentive for Production: By guaranteeing a minimum price, price floors can provide an incentive
for producers to continue producing even when market prices are low, ensuring a consistent supply
of essential goods.
 E VA L U AT I O N P R I C E F L O O R :
N E G AT I V E S
Surpluses: One of the primary drawbacks of price
floors is the potential for surpluses, where the
quantity supplied is more than the quantity demanded
at the government-mandated minimum price. This
can result in excess goods going to waste or requiring
costly storage.

Inefficiency: Price floors can lead to resource

misallocation. When goods are produced in excess
due to guaranteed prices, resources may be used
inefficiently, which can hinder economic growth.

Higher Costs for Consumers: Price floors can result in

higher prices for consumers, particularly if the
government-mandated minimum price is set well
above the market equilibrium price.
 E VA L U AT I O N P R I C E F L O O R :
N E G AT I V E S
Administrative Costs: Enforcing and monitoring price
floors can be administratively expensive for
governments.
Export Issues: If the domestic price floor exceeds the
international market price, it can lead to difficulties in
exporting goods, as they are less competitive on the
global market.
Black Markets: In some cases, price floors can
incentivize black markets where the goods are sold at
lower prices than the government-mandated
minimum, circumventing the intended price controls.
Income Inequality: Price floors may not necessarily
benefit all producers equally. Larger producers may
benefit more than smaller ones, potentially
exacerbating income inequality within an industry.