Government Intervention Introduction Government Intervention is considered as an action which is taken by the government that helps to modify or change

economic liveliness, supply ability, and the unconstrained decisions made through normal market trade. The government intervenes or takes an action to intrude the market as soon as when;

The market is not efficient (Market Failure) Where the marginal benefit to the society exceed the marginal cost of the society Value of good or service exceeds the value of good or service used to produce it.
The market failure is caused by Lack of competition Transaction costs Lack of information Negative externality

Marginal Benefits Exceed marginal cost - The term marginal cost refers to the opportunity cost allied with producing one more additional unit of a good. Opportunity cost is a critical concept to economics it refers to the value of the highest value alternative opportunity. For example, in examining the marginal cost of producing one more bushel of wheat, that number could be expressed as the dollar value of corn or other goods that could be produced in lieu of more wheat. Marginal benefit refers to what people are willing to give up in order obtaining one more unit of a good, while marginal cost refers to the value of what is given up in order to produce that additional unit. Additional units of a good should be produced as long as marginal benefit exceeds marginal cost. It would be inefficient to produce goods when

the marginal benefit is less than the marginal cost. Therefore an efficient level of product is achieved when marginal benefit is equal to marginal cost. URL LINK http://www.investopedia.com/study-guide/cfa-exam/level1/microeconomics/cfa5.asp Value of good or service exceeds the value of good or service used to produce it It happens when price of a good for example apple manufacturing cost is $ 5 and it is being sold at $ 7 so it shows the value of apple to exceed the value of apple used to produce. The government mainly intervenes in the field of price, improvement in economic and social welfare and affecting changes over negative externalities. The government chooses to intervene in the price mechanism for food industry largely because the grounds of wanting to change the allocation of resources and achieve what they have perceive to be an improvement in economic and social welfare. Government Intervention is necessary because majority would think that the market is efficient and with an outgoing demand and abundant supply consumers are paying for low cost food and are happy to save hours of prepping time. Producers receive sale profit and continue to market and develop new manufactured food. The private cost seems low comparing the explicit private benefits which the consumers receives. Upon closure examination on the market it can be seen that government intervention on food industry is considered a good deal because producers of food industry are only interested in maximizing their profits. They only take into consideration the private costs incurred and private benefits arising from their products or to offset the social costs as a result of protracted consumption of food because they are not willing to reduce the supply nor the demand of their products where else the consumers are willing to pay less for good amount to be provided. Both producers and consumers will only consider private costs and private benefits, resulting in an efficient market with negative externality. Government Intervention is necessary to ensure a balance state on both sides and so that negative externality does not arise. All governments of every political

persuasion intervene in the economy to influence the allocation of scarce resources among competing uses. The main reasons for policy intervention are:

To correct for market failure To achieve a more equitable distribution of income and wealth To improve the performance of the economy Control non competitive behavior Change income distribution

Methods of Government Intervention and Possible Effects The government can intervene via two major avenues, firstly the government can target the issues related to imperfect maximization of price rise by allowing external social cost not to increase this is considered as Maximum and Minimum price. In this case the government determines the price and not the price mechanism. There are two types of price control Ceiling Price Floor Price Ceiling Price Ceiling price is considered as government imposed rules and regulations which control the price from increasing above the maximum level which will be determined by the government. Government directly helps the consumers to best satisfy their interest. Ceiling price is normally set below the equilibrium price and the sellers are not allowed to increase the prices. Ceiling price is considered as maximizing price levels. The government surveys the market and signifies that the price of essential necessary commodities is most likely to increase, so the government imposes a ceiling price on those commodities. Example of these commodities can be rice, sugar, salt, cooking oil cement, petrol, diesel, wheat, flour, etc.

Advantages of Ceiling Price The main advantages of ceiling price is consumers can buy goods and services and products of food at lower prices. Ceiling price mainly attracts the consumers point of satisfaction. For example equilibrium point price for 1 Kg rice is $20 and the government has set the ceiling price to be $19 per Kg, so from this it can be seen that the consumers are having benefits of $1 per Kg. so by doing this shortage will occur which is explained with a graph below.

PRICE

S Eo P* P1
SHORTAGE
PRICE CEILING/ MAXIMUM PRICE

D
QUANTITY KG

Q*
Fig - 1

As from the above graph it can be seen that fixing the price level below the equilibrium level creates an excess in demand or shortage. Shortage result will occur because the quantity demanded is more than the quantity supplied. Efficiency occurs since at the price ceiling quantity supplied the marginal benefit exceeds the marginal cost. This inefficiency is equal to the deadweight welfare loss. For example, as we can see bellow the recent drought in Russia has caused a severe drop in the countrys grain supply capacity. This drop in supply is represented by a shift from S1 to S2. S1 represents the countrys supply of grain before the drought, while D1 represents Russias demand for grain. As we can see, the supply and demand for g rain in Russia is equal prior to the droughts. This is represented by the fact that Q1, the quantity of grain being supplied, is located along in the intersection of both S1 and D1.

This is called equilibrium, or the point at which both the supply and demand are satisfied. Fig 2: A shift in supply for grain in Russia
S2 Price S1

Shortage P1

D1 0 Q2 Q1 Grain supplied

In this situation the Russian government can set the ceiling price which is being shown in Fig 1 where commodities will be sold under equilibrium price set. Imposing a price ceiling would help keep grain affordable in the market for all classes, especially the poor farming class, who are expected to take the biggest hit from the droughts. The price ceiling also creates a shortage of grain in the country, as the quantity supplied falls below equilibrium. Responding to this, the Russian government is using its grain reserves to help boost the economys supply of grain temporarily and keep grain affoedable and available for everyone. URL LINK http://12congwi.wordpress.com/2010/10/03/russia-considering-priceceiling-on-food/ Disadvantages of ceiling price can be Emergence of Black market Reduces quantity produced Producers tend to receive illegal payments from customers

Emergence of Black market It arise when the supply of commodity is less in the market because food commodity suppliers may stock loads to sell later with higher price more than the ceiling price set because the demand for it is higher in the market and the supply is low, which will attract consumers to buy at higher price to fulfill their wants. Reduces Quantity produced As it is being seen from the above ceiling price is being set under the equilibrium price and is set to be cheaper. In this matter the producers produce lesser commodities because they have to manufacture at higher price and have to sell at lower price because the quota is being set by the government to sell under equilibrium point. Illegal Payment from customers As the supply is low and the demand is high, the producers get special attention from customers to supply them more and they are willing to pay more for it, which can misguide the supply sector to negative reaction. Floor price Floor price is considered as to be the minimum price level, this mainly concentrates on to the price which should stay on to a minimum level and which is being set by the government. This is mainly done to save the farming industry or agriculture sector to protect the farmers in the event where the price of commodities is too low in the free market. Example can be government imposes a price level where the farmers can increase their income. The price level is basically set above the equilibrium point price. Another example can be minimum wage rate a minimum amount is being set for the employers to pay the workers to protect themselves from getting exploited. Advantages of Floor Price is classified below Protects producers income Higher wage rate

Protects producers income As the price is being set over the equilibrium price the producers can earn more from what they sell and they can protect their income by selling at higher price and also coping with the more earning which will be left after selling. Higher Wage rate If the producer can sell above the equilibrium point and earn more profits, in this case the producers can employee more people and can pay higher wage rate to produce more output.

Disadvantages of Floor Price is classified below Consumers pay more Waste of useful resources of production material Creates unemployment

Consumers pay more As the price is being set over the equilibrium price consumers has to pay more because the output price is being set more by the government. Waste of resources As price is high and demand is low producers buy in bulk amount and store it and sometimes it is seen that they cannot manage to sell everything which leads to waste of valuable resources. Creates Unemployment As prices are high and demand is low the producers do not need to produce more because they have sufficient in storage and they do not need to employee new people which will lead to unemployment.

So if floor price is included and fixing the price above equilibrium price level surplus will occur which is explained with a graph below. A surplus will exist because quantity demanded is less then quantity supplied.

PRICE

SURPLUS

S
PRICE FLOOR/ MINIMUM PRICE

P2 P*

D Q*
QUANTITY KG

Secondly the government can impose Tax on the market just for the fact to alternate the market not to raise the price. Intervention may be used to introduce fresh competition into a market for example breaking up the existing monopoly power. A good example of this is the attempt to introduce more competition. This is known as market liberalization. The possible effect from intervention can be consumers suffer from market failure result suffering from lack of information about the costs and benefits of the products available in the market place. Government action can have a role in improving information to help consumers and producers value the true cost and/or benefit of a good or service. URL LINK http://tutor2u.net/economics/revision-notes/as-marketfailure-governmentintervention-2.html