Section 8-Government

Microeconomic Intervention
Externalities
• Deadweight loss: the welfare loss when due to market failure desirable consumption

and production does not take place. A deadweight loss is a cost to society created

by market inefficiency, which occurs when supply and demand are out of equilibrium.

Mainly used in economics, deadweight loss can be applied to any deficiency caused by

an inefficient allocation of resources.

• Equality means each individual or group of people is given the same resources or

opportunities.

• Efficiency: The term efficiency refers to the peak level of performance that uses

the least amount of inputs to achieve the highest amount of output. Efficiency

requires reducing the number of unnecessary resources used to produce a given

output, including personal time and energy.

• Equity recognises that each person has different circumstances and allocates the exact

resources and opportunities needed to reach an equal outcome. The distribution is fair.

• Horizontal and vertical equity: Horizontal equity refers to the idea that people in

the same circumstances should be treated in the same way. Vertical equity refers

to the idea that people on higher incomes should take on a greater share of the

responsibility for paying for public services.

• Nudge theory- proposes positive reinforcement and indirect suggestions as ways to

influence the behavior and decision-making of groups or individuals. It is basically

encouraging consumers to make rational decisions or ones in their self-interest. For

 example, giving them information about the negative effects of smoking to encourage

them to quit.

• Privatization: where there is a change in ownership from the public to the private sector.

Imposition of indirect tax:

Externality occurs when the marginal social benefits (MSBs) differ from the marginal

private benefits (MPBs); equally, it is when the MSCs are not equal to the MPCs

Such differences occur in four situations:

• negative externalities in production

• negative externalities in consumption

• positive externalities in production

• positive externalities in consumption

Intervention to correct externalities takes many forms including:

• use of indirect taxes

• various types of regulation

• property rights

• provision of information
• pollution permits

• subsidies
 Inequality
Lorenz curve: a graphical representation of inequality.

Gini coefficient: a numerical measure of inequality There are three main types of

policies that are available to reduce inequality in the distribution of income and wealth.

The more the Lorenz curve shifts towards the equality line the better

Gini coefficient= (area A)/(area A+B)

These are:

1. providing benefits Means-tested benefits: benefits that are paid only to those whose

incomes fall below a certain level. Poverty trap: where an individual or a family are

better off on means-tested benefits rather than working. Universal benefits: benefits that

are available to all irrespective of income or wealth.

2. through the tax system Progressive tax: one where the rate rises more than

proportionately to the rise in income. Regressive tax: one where the ratio of taxation to

income falls as income increases.

3. through other policies. A further way of reducing inequalities in society is for the

government to provide certain important services free of charge to the user. The two

most significant examples of such free provision in many economies are health care

and junior and secondary education

Negative income tax: a unified tax and benefits system where people are taxed or

receive benefits according to a single set of rules. Derived demand: where the demand

for a good or service depends upon the use that can be made from it

Labour
Shifts in the long run supply of labour
 Labour demand: Demand for labour is a concept that describes the amount of demand

for labour that an economy or firm is willing to employ at a given point in time

MRPL: The marginal revenue product of labour (MRPL) is the change in revenue that

results from employing an additional unit of labour, holding all other inputs constant

Two important features of the workings of labour markets. These are:

1. the wage paid to labour equals the value of the marginal product of labour

2. the willingness of labour to supply their services to the labour market is dependent upon

the wage rate that is being offered

equilibrium in labour market

 Increase in demand for labour causes rise in employment and rise in wages Increase in

supply for labour causes rise in employment and fall in wages

1. Transfer earnings: This is the minimum payment necessary to keep labour in its present

use. For example, the government will give the unemployed people benefits so that

when there is the need for that labour, the labour is available.

2. Economic rent: Any payment to labour which is over and above transfer earnings. This

is usually the salary given to the people.

Trade union and minimum wage

trade unions aim to:

• increase the wages of their members

• improve working conditions

• maintain pay differentials between skilled and unskilled workers

• fight job losses

• provide a safe working environment

• secure additional working benefits

• prevent unfair dismissals

Monopsony: where there is a single buyer in a market.

Government failure
Government failure: where government intervention to correct market failure causes

further inefficiencies. There are three main reasons why government failure may occur.

These are as a result of:

1. imperfect information There is a lack of information about the true value of a negative

externality. There is a lack of information about the level of consumer demand for a

product.

2. undesirable incentives The imposition of taxes can distort incentives. Politicians may be

motivated by political power rather than economic imperatives.

3. policy conflict.

However, it is possible that government intervention might sometimes increase existing

inequality. this is simply understood by recognising that the imposition of any tax will

have a distributional effect.

Nudge theory: to use encouragement and suggestions to change people’s behaviour for

better.

Monopsony and labour market failure

Monopsony

It is the type of market where there is only one buyer and multiple sellers.

Monopsony power of employers: dingle buyer of a particular type of labour. They pay

relatively lower wages and employ less people in a competitive labour market.

Trade unions can help the problems caused by monopsonist but only till some extent.

They can negotiate a minimum wage but their employment can go down too.

Labour market failure

• skill gaps- less skills so employees are not quite productive

• geographical immobility- can’t migrate

• economic inactivity- education or illness

• inequality and discrimination

• working poverty- people work but income is less

• monopsony power of employers

How to solve labour problems

• minimum wage for low paid jobs

• legal protection of basic rights

• higher trade union membership

• enhanced scrutiny of mergers