8. Government microeconomic intervention

Governments may address market failure with taxes, subsidies, regulation, tradable permits, direct provision, information, competition policy or assignment of property rights.

Choose the instrument by asking what is missing: a tax can internalise a cost, a subsidy can encourage an external benefit, information can reduce asymmetric knowledge, and competition policy can limit market power. Estimate implementation and enforcement costs.

A pollution tax aims to move private cost toward social cost; if emissions are difficult to monitor, a standard or permit system may be more practical than a perfectly calibrated tax.

“Government intervention” is not a cure by definition: policy can overshoot, be captured or cost more than the welfare gain.

Government failure occurs when intervention creates a larger welfare loss than the market problem it was intended to correct, or fails to improve the outcome at reasonable cost.

Causes include imperfect information, administrative cost, unintended incentives, regulatory capture, political short-termism, rent-seeking and weak enforcement. Compare the policy outcome with the realistic counterfactual, not with a perfect textbook market.

A subsidy intended to reduce pollution may increase output if it is poorly targeted, while a regulation that is cheap to comply with may deliver little environmental benefit because firms can evade it.

Government failure does not prove markets are always efficient; both the original market failure and the feasible intervention must be assessed.

Equality means giving people the same treatment, resources or outcome. Equity means judging what is fair, which may require different treatment to account for needs, barriers or contributions.

A policy can increase equality of income while reducing perceived equity, or improve equity through targeted support without making incomes equal. The criterion must be stated rather than assumed.

Giving every learner the same textbook is equal; providing accessible materials to a learner with a visual impairment may be more equitable while using different resources.

Equity is not a synonym for equality, and a measured equal outcome does not prove the process or opportunity was fair.

Efficiency concerns maximising or avoiding waste of resources; equity concerns the fairness of distribution or opportunity. A policy can improve one without improving the other.

Redistribution may reduce inequality but weaken incentives or create administrative costs; an efficient market outcome may leave people without a socially acceptable share. The size of the trade-off is empirical, not a universal rule.

A progressive tax can finance education that raises opportunity and productivity, potentially improving both equity and efficiency; a badly designed tax may reduce work or investment more than the gain.

“Efficient” does not mean fair, and “equitable” does not automatically mean economically wasteful.

Absolute poverty means lacking resources to meet a defined minimum standard of basic needs. Relative poverty means having substantially fewer resources than the typical or median household in the society.

Absolute measures track purchasing power against a threshold that may be updated; relative measures reflect participation and inequality within a society. A person can move above an absolute line while remaining relatively poor if others’ incomes rise faster.

If a household’s real income doubles but the median income triples, absolute hardship may fall while its relative position worsens.

Neither measure alone captures every dimension of deprivation, and “poor” is not determined only by a single income number.

A poverty trap is a self-reinforcing cycle in which low income limits saving, health, education or investment, which keeps productivity and future income low.

The cycle is a mechanism, not a claim that every low-income household is unable to escape. Credit constraints, risk, poor infrastructure and unequal access can prevent a profitable investment from being made.

A farmer without affordable credit cannot buy irrigation; low yields keep income low, so the next season the same constraint remains. A targeted loan or infrastructure can break the cycle if it reaches the binding constraint.

The trap is not simply “people are poor because they do not work”; identify the missing asset, market or opportunity that reproduces poverty.

Policies include progressive taxation, transfers, minimum wages, public education and health, targeted benefits, anti-discrimination rules and measures that improve access to assets or employment.

Evaluate each policy by the group reached, incentive response, administrative cost, incidence, time horizon and whether it changes opportunity or only current income. Universal and targeted approaches involve different coverage and stigma trade-offs.

A cash transfer can reduce current poverty quickly; high-quality early education may improve opportunity and future productivity but takes longer to show in income data.

A policy’s label does not prove who benefits: a statutory minimum wage can help some workers and reduce jobs for others depending on the labour market.

A firm’s demand for labour depends on the marginal revenue product of labour: the extra revenue generated by one more worker, which combines marginal physical product with the value of output.

Demand tends to rise when product demand or price increases, worker productivity improves, or complementary capital becomes more effective. It falls when the wage exceeds the value of the worker’s marginal contribution.

If an extra worker produces 10 units and each sells for $5, marginal revenue product is$50 before considering other changes. A wage below that may make hiring worthwhile; a wage above it may not.

Labour demand is not determined by workers’ preferences alone; it is a derived demand linked to demand for the product and the productivity of labour.

A firm’s demand for labour is derived from the demand for its product. It tends to rise with a higher product price, stronger product demand, higher worker productivity or more productive complementary capital.

The wage is one determinant, but it moves along the labour-demand curve rather than shifting it in the simplest model. Technology can substitute for labour or complement it, so “technology raises demand” is not a universal rule.

A rise in demand for restaurant meals raises the value of extra servers; a labour-saving ordering system may reduce demand for routine tasks but increase demand for technicians.

Do not treat a higher wage as a shift in labour demand, and do not assume all workers are affected equally by a technology change.

A movement along the labour-demand curve follows a change in the wage, holding other conditions constant. A shift changes demand at every wage because product demand, productivity, output price or complementary inputs change.

State the changed variable before drawing. A wage rise usually reduces quantity of labour demanded; higher product demand can shift the whole curve right even if the wage is unchanged.

A café hiring fewer workers after the hourly wage rises is a movement. A festival that increases demand for meals shifts the café’s labour demand right.

A new employment equilibrium does not by itself prove a labour-demand shift; compare the determinant, not just the observed quantity.

Marginal revenue product (MRP) is the additional revenue created by one more worker: MRP = marginal physical product × marginal revenue. A firm hires labour up to the point where MRP equals the wage in a competitive labour market.

Because marginal physical product often falls as more labour uses fixed inputs, MRP can slope downward. The relevant revenue may be product price for a price-taking firm or marginal revenue for a price-setting firm.

If the next worker adds 6 units and each unit adds $8 of revenue, MRP is$48. Hiring is profitable when the wage is below $48, subject to other costs and constraints.

MRP is not just physical productivity, and the wage is not always equal to MRP if the firm has labour-market power.

Labour supply is the amount of labour workers are willing and able to offer at different wage rates. It depends on the wage, non-wage benefits, working conditions, preferences, skills, migration and the opportunity cost of leisure.

At individual level, a higher wage can encourage work by raising the reward, but at high incomes the income effect may encourage more leisure. Market labour supply also reflects population, participation and occupational mobility.

A flexible schedule may attract workers even at the same wage; a shortage of childcare can reduce the hours supplied despite a higher hourly rate.

Labour supply is not simply the number of people of working age, and willingness to work is not the same as being employed.

A movement along labour supply follows a change in the wage. A shift changes the quantity offered at every wage because population, migration, skills, preferences, taxes, benefits or working conditions change.

Separate an individual’s response from a market-wide change. Better childcare or immigration can shift supply right; a wage rise changes quantity supplied along the existing curve unless it also changes another determinant.

A higher wage may attract more nurses along the curve. A new training programme increases the number qualified and can shift the market supply curve right.

Do not draw a supply shift merely because employment rose; identify whether the wage or the underlying labour pool changed.

In a perfectly competitive labour market, many employers and workers take the market wage as given. Equilibrium employment occurs where labour demand equals labour supply.

The wage reflects the value of the marginal worker to firms and the opportunity cost of that worker’s time. A wage above equilibrium creates excess supply; a wage below it creates excess demand, assuming adjustment is possible.

If the market wage is set above the intersection, more people want jobs than firms want to hire, creating unemployment. A wage below the intersection leaves vacancies or unmet labour demand.

The equilibrium wage is not necessarily fair or a living wage, and the competitive model does not describe monopsony or strong bargaining power.

In an imperfect labour market, one or more employers or worker groups have bargaining power, information advantages or barriers to movement, so the wage is not set by a simple market-clearing intersection.

A monopsony faces an upward-sloping labour supply and may hire where marginal labour cost equals marginal revenue product, paying a wage below the competitive level. Trade unions can raise wages or improve conditions, but effects depend on bargaining power and demand elasticity.

A dominant local hospital may face little competition for nurses; a union can counterbalance that power, though a large wage rise may reduce employment if labour demand is elastic.

Imperfect competition does not always mean lower wages: collective bargaining or professional scarcity can raise them.

A wage differential is a difference in pay between workers or occupations. It can reflect marginal productivity, education and training, scarcity, risk, working conditions, discrimination, bargaining power and institutional rules.

Compare jobs on the same basis: a higher wage may compensate for unpleasant risk, require scarce qualifications or reflect a union. Observed pay can also diverge from productivity because information and discrimination distort the market.

A hazardous offshore job may pay more partly as a compensating differential; a shortage of specialist engineers can raise pay through scarcity even when working conditions are attractive.

A high wage is not proof that a job creates more social value, and a low wage is not proof of low productivity.

Transfer earnings are the minimum payment needed to keep a factor in its present use. Economic rent is any payment above transfer earnings. Total earnings equal transfer earnings plus economic rent.

The split depends on the elasticity of supply to that use. A factor with few alternatives has high economic rent; a factor that can move easily has a larger transfer-earnings component.

If a singer would accept $30,000 to stay in a show but is paid$80,000, transfer earnings are $30,000 and economic rent is$50,000.

Economic rent is not the same as profit, and a high payment can contain little rent if the factor has an attractive alternative.