Revise Methods and effects of government intervention in markets for Cambridge 9708 (3.2)

An indirect tax is a levy imposed by the government on expenditure, collected by producers and paid to the government. There are two types: a specific tax (a fixed amount per unit) and an ad valorem tax (a percentage of the price). Both increase the costs of production, causing the supply curve to shift vertically upwards. A specific tax causes a parallel shift, while an ad valorem tax causes a pivotal shift. This leads to a new, higher equilibrium price and a lower equilibrium quantity. The tax revenue for the government is the tax per unit multiplied by the new quantity. The burden of the tax, known as tax incidence, is shared between consumers and producers, with the relative share depending on the price elasticity of demand (PED) and supply (PES). This intervention creates a deadweight loss, representing the loss of welfare to society.

A subsidy is a grant from the government to producers to lower their costs of production and encourage an increase in output. It is effectively a negative indirect tax. A subsidy shifts the supply curve vertically downwards by the amount of the subsidy per unit. This results in a lower equilibrium price for consumers and a higher quantity traded in the market. Producers receive the new, lower market price plus the subsidy per unit. The total cost to the government is the subsidy per unit multiplied by the new, higher quantity. While subsidies increase both consumer and producer surplus, they can lead to allocative inefficiency by encouraging production and consumption beyond the socially optimal level, creating a deadweight loss from overproduction.

A maximum price, or price ceiling, is a legally imposed limit on how high a price can be charged for a product. To be effective, it must be set below the free-market equilibrium price. The primary intention is to make essential goods and services, such as food or housing rent, more affordable for low-income households. However, the main consequence is the creation of a persistent shortage (excess demand), as the quantity demanded at the ceiling price exceeds the quantity supplied. This can lead to inefficient non-price rationing mechanisms like queuing, as well as the emergence of illegal 'black markets' where the good is sold at a much higher price. While some consumers benefit, overall market welfare is reduced, creating a deadweight loss.

A minimum price, or price floor, is a legally imposed limit on how low a price can be charged. To be effective, it must be set above the free-market equilibrium price. This policy is often used in agricultural markets to guarantee a stable and higher income for farmers, or in labour markets in the form of a national minimum wage. The primary consequence is a persistent surplus (excess supply), as the quantity supplied at the floor price exceeds the quantity demanded. To maintain the minimum price, the government often has to intervene by purchasing the surplus stock, which incurs a significant opportunity cost. This leads to allocative inefficiency as resources are used to produce goods that consumers do not wish to buy at that price.