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Market Failure and Government Intervention

Figure 17-7  Regulation

1.

The minimum output control.  The government mandates a minimum acceptable output that must be provided (dotted line).  The provider can only achieve the “current price” but needs a much higher price to offer the service (at the upper end of the dotted line).  The government must make up the difference with a subsidy.  Through time such subsidies tend to grow.

2.

The minimum price control (the price floor).  The government tries to prevent prices from falling below a particular price floor (dotted line).  A surplus results, measured by the difference between the quantity supplied (right end of dotted line) and the quantity demanded at the price floor.  Goods sit and decay in inventory.  Alternative markets form to dispose of the unwanted surplus. Capacity to produce new goods or services migrates out of the market.

3.

Maximum price control (price ceiling).  The government tries to prevent prices from exceeding a particular ceiling price (dotted line).  A shortage results measured by the difference between the quantity demanded (right end of the dotted line) and the quantity supplied at the price ceiling.  People stand in line waiting for commodity.  Alternative markets appear to get hold of the output, but the original sellers do not get to take advantage of the higher prices on these alternative markets.  

4.

Maximum output control.  This include cases of “prohibitions or “zero tolerance” where an activity is prevented from happening at all.  The “current price” for anyone who wants the goods is far above the equilibrium price that would occur without this maximum output control.  Typically it is provided illegally by smugglers willing to risk breaking the law.  The higher prices subsidize these smugglers.

Typically all of these controls become harder to maintain as time passes.  The guidelines on

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