Irfaan Jaffer IB1TPrice Controls:

If the government is able to shift the supply curve to the right, by subsidising, direct provision or using stored stock them the equilibrium will be reached at Pmax. With Q2 being demanded and supplied.If this happens e.g. subsidising, the government would incur a cost a cost e.g. education healthcare etc.Minimum (high) Price Controls:This is where the government sets a minimum price above the equilibrium price, which then prevents producers from reducing the price below it.It is also known as floor prices since the price is not able to go below the floor.Reasons for setting minimum price:1) To attempt to raise incomes for producers of goods and services that the government thinks are important, e.g. agricultural goods. Producers benefit because of price fluctuations (volatility) or foreign competition.2) Protecting workers by setting a minimum wage to ensure that the workers earn enough to lead a reasonable existence.Minimum Price in The Market of A Product:

Without government interference, the equilibrium Qd and Qs would be Qe at price Pe.The government imposes a minimum price of Pmin in order to increase the revenue of the producers. However at price Pmin, Q1 will be demanded because price has risen, but Q2 will be supplied, hence excess supply.Excess supply will make the producers sell their excess supply for a lower price, somewhere between Pmin and Pe.

Government Action to Solve the Problem of Excess Supply:There are 3 solutions:1) Buying the excess supply:a. The government would eliminate the excess supply by buying out the surplus products at the minimum price, thus shifting the demand curve to the right and creating a new equilibrium at Pmin with Q2 being demanded and supplied.b. The new demand curve would be D+government buying.c. The government would store the surplus or attempt to sell it abroad.d. Storage is expensive, hence selling abroad is an option. However, foreign governments involved might claim that the products are being dumped on their markets and will harm their domestic industries.e. In some cases, e.g. European Union Policy, farmers are guaranteed a minimum price and are then paid to set aside land that they would have used to produce the product. They are then paid the estimated price for a harvest and nothing is actually grown. This costs the same for the government, but avoids storage costs or destroying produce.f. In order to buy the surplus, the government still has an opportunity cost.2) Having quotas:a. The producers could be limited by quotas, so that it does not exceed Q1. This would keep the price at Pmin, but would mean that only a limited number of producers would receive it.

3) The government could increase demand for the product by advertising or by restricting supplies that is being imported. This will increase the demand for domestic products.Products of Granting Minimum Prices:1) Firms may not be cost conscious, hence inefficiency and waste of resources.2) Firms may produce more of the protected product and less of the product, that they could have produce more efficiently.

Market Failure:Markets are not perfect, thus there is no allocative efficiency.Due to imperfect markets, community surplus is not maximised, hence market failure.When the market fails, the government intervenes to attempt to eliminate market failure, hence moving towards allocative efficiency.Types of Market Failure:1) Lack of public goods:a. Public goods are goods that will not be provided at all in a free market.b. They are goods that are of benefit to the society, hence their lack is a market failure.c. Some public goods, e.g. street lighting, can be provided by the free market, known as quasi-public goods.

Characteristics of Public goods: They are non-excludable, i.e. once they have been provided, stopping anyone from its consumption is impossible. They are non-rivalrous, i.e. when one is consuming it, you cant stop another person from consuming it simultaneously. Government measures to reduce market failure: They may provide the public goods themselves, e.g. defence, flood barriers, street lighting etc. They may subsidise private firms covering all costs to provide the good.

2) Undersupply of Merit Goods:a. These are goods that will be undersupplied when left to the free market, hence will be under consumed.b. Merit goods are goods that the government thinks have positive benefits to the society. Examples are:1. Education.2. Healthcare.3. Sports.c. Supply is increased by the government through subsidies from the tax payers.3) Oversupply of Demerit goods:a. Demerit goods are goods that will be overprovided when left to the free market, hence will be overconsumed.b. These are goods that the government thinks are bad for both the consumers and the society as a whole, e.g:1. Hard drugs.2. Cigarettes.4) The Existence of Externalities:a. An externality occurs when the production or consumption of a good or service has an effect on the 3rd party.b. There is an external cost that must be added to the private cost or consumer to reflect the full cost of society.c. Marginal social cost (MSC) is equal to marginal private cost (MPC) plus or minus external cost or benefit of production.d. If there are no externalities of production, then MSC=MPC.e. The MPC is the private supply curve that is based on the firms costs of production.f. MSB = MPB (Marginal private benefit) plus or minus any external cost or benefit of consumption.g. The MPB is the private demand curve that is based on the utility or benefit to consumers.h. If no externalities exist in a market, then MSC= MSB and we have social efficiency thus maximum community surplus.

Types of Externalities: Negative externalities of Production:a. Occurs when production of goods and services creates external costs that are damaging to 3rd party. i. Example: If a paint factory emits fumes that are harmful to the people in the area, there will be a community cost that is greater than paint production cost.b. The firm has its private cost and then creates external costs, thus marginal social cost is greater than marginal private cost, i.e. MSC=MPC+ external costs.

c. MSC is above MPC because extra cost is created by pollution.d. If the Firm is concerned with its private cost, it will produce Q1, not producing at the socially efficient output.e. There is a misallocation of societys resources, i.e. too much paint at a price that is too low.f. There is a welfare loss to society of the extra units from Q1 to Q*, since MSC>MSB.Government Measures to Eliminate Welfare Loss:1) Taxes:a. The government could tax firms private costs and so shift the MPC curve upwards to the point of social efficiency.2) Law:a. The government would legislate and could ban the polluting firms, or restrict their output.3) Tradable emission permits:a. Tradable emission permits give firms licenses to create pollution up to a certain level.Positive Externalities of Production/ External Benefit:1) These occur when the production of a good or service creates external benefits that are good for 3rd parties, i.e. MPC>MSC.

Positive Externalities of Consumption:1) There are some goods, when consumed will provide external benefit to the 3rd party, e.g. when people consume healthcare, they create a positive externality for the society since there will be no spread of diseases to the society. Healthier workforce means a more productive economy, hence benefit for the whole population.

2) In a free market, people will consume Q1 at a price P1, however the socially efficient of consumption would be Q*, where MSB=MPB. If consumption of goods like healthcare, education etc. increases from Q1 to Q*, then welfare in the society will increase.

Government Measures to Increase Welfare Gain (in consumption): The government would subsidize these goods and services. The problem is the cost. The developing countries may not be able to fund this goods and services.

The government could use positive advertising. However, this has many disadvantages:i. Extra cost to the government.ii. May be not be effective in the short run. The government could pass laws insisting that citizens get vaccinated in case of diseases, or have regular checks, problems are:i. Will be successful if it is free of charge.ii. People see it as an infringement of their civil liberty.Common Access Resources and Further Threats to Sustainability: Common Access Resources can also be called common-pool resources or common-property resources. Common access resources are typically natural resources e.g. fishing grounds, forests, pastures etc. The problem is that it is very difficult or very expensive to exclude people from using these resources. This is likely to encourage overuse or overconsumption and hence depletion of the resources. E.g. if there are fishing grounds near to a village and villagers have open access to them, they will fish and take as many as they want. This is because each fish adds marginal utility for the individual. Marginal utility is the extra satisfaction a person gets by consuming one more unit of a good or service. If this fishing harms the stock of fish, the damage is shared by the entire group, including future generations. Private benefit is greater than external cost, hence market failure due to overconsumption (no sustainability). Sustainability exists where the consumption and needs of the present generation are met without reducing the ability to meet the needs of the future generation. Further Threats to Sustainability:1) Deforestation:a. Low income people in developing countries depend on wood as their only source of fuel and wood (timber).

Effects of Deforestation:i) Households who need wood must travel for greater distances to acquire wood for fuel.ii) Due to greater travelling distances, they will have less time to earn income for their households.iii) Hence they are trapped in a vicious cycle, hence overuse of the resources.iv) Loss of vegetation may lead to flooding and landslides with heavy external costs. Suppose the forested land is owned by the company. The main aim of the company will be to maximize profits from the wood it produces. The company will consider private cost and ignore external cost to present and future generations, e.g. loss of biodiversity, flooding, soil erosion etc. Thus, there will be overuse and under-pricing of wood products. Many resources will have been allocated to the production of this wood products, consequently negative externalities of production.

2) The use of fossil fuels:a. The extraction and use of coal, oil and natural gas generate external costs which may pose immense threats. b. When fossil fuels are burnt, the CO2 and other greenhouse gases are emitted.c. These gases trap heat in the atmosphere and are linked to climate change.d. Consequences of climate change include:i. Flooding of costal areas.ii. Changes to agricultural patterns.iii. Extreme weather conditionsEtc.e. This climate change has massive external costs.f. Vehicles emit Carbon Monoxide which is a major contributor to air pollution.g. Companies burn coal to produce electricity. Nitrogen oxide and sulphur oxide are produced as a result. h. This leads to acid rain which causes problem for vegetation and crops and damages buildings.i. The production and transport of oil is subject to the risk of oil spills with massive external costs to the environment, marine life, animals and coastal communities.j. Air and water pollution, due to mining, pose health and environmental consequences in their regions.Government Responses to Threats to Sustainability:

1) Cap and tradable systems:a. Government may set national targets for emission reductions and encourage firms to meet the targets by creating an economic incentive.b. E.g. the Kyoto protocol, an agreement made under the United Nations under convention on climate change (UNFCC). The treaty was negotiated in Kyoto in 1997 and came into force in February 2005.c. In November 2009, 187 countries had rectified the agreement, committing themselves to the reduction.2) Clean technologies:a. Much attention has been paid to the use of renewable energy sources as a solution to externalities created by fossil fuels.b. Other types of clean technologies include efforts to energy efficient cars, homes, buildings, lighting and appliances.c. Government can assists by subsidising or by offering tax credits to firms that invest in clean technologies.d. E.g. a firm producing electricity using wind-power with turbines will make Q1 electricity at price P1.

The government subsidy will lower the firms costs of production, thus increasing supply from s1 to S1+subsidy, making more electricity (Q20, available at a lower price, P2, to consumers. This results to a higher revenue for the firm hence, incentive to produce higher amounts of wind power. Since this form of electricity is a substitute for electricity produced through burning of fossil fuels, resources will be allocated away from using fossil fuels towards cleaner renewable energy sources.Imperfect Information:i) If buyers and sellers come together in a market, there will be allocative efficiency if they are all aware of what products are available and the range of prices, hence no externality.Asymmetric Information:ii) This is where one party in an economic transaction has access to more information or better information than the other party. Thus the market will not reach the allocative efficiency level of output.iii) Mostly the producer has more information and hence charges a higher price.iv) Technology has had the effect of increasing the flow of information in markets and consumers are increasingly able to access all kinds of information as a result of research conducted on the internet.Imperfect Competition: Monopolists and other imperfect markets restrict outputs in order to push up prices and maximise profits. Consequently, not producing at the socially efficient level of output, i.e. MSC is not equal to MSB. Because profits are maximised where MC=MR (marginal cost = marginal revenue), Q1 will be produced at a price of P1 and the socially efficient level of output, Q* is not reached.

Community surplus is not maximised, this market failure. When community surplus falls from the maximum, it is said to be a welfare loss.

Government Measures to Reduce this Market Failures:1) They use legal measures to make markets more competitive, e.g. passing laws with dont allow mergers, takeovers, etc.2) They may set up regulatory bodies to investigate markets where monopoly power is used against the public interest, e.g. monopoly commissions or monopoly watch dogs.