Examine the concept of market equilibrium and discuss the reasons for and methods of government intervention in markets Market equilibrium is a situation in which the supply of an item is exactly equal to the demand of that item, there is no surplus nor shortage. Under the circumstances of market equilibrium, prices tend to remain stable. Producers and consumers react differently to changes in price, higher prices are prone to reduce demand, while supply will increase, and when prices fall there tends to be a higher demand, and a reduced supply. In other terms, an increase in price means a drop in demand and a rise in supply, and vice versa.
Equilibrium Equilibrium As shown in figure 1, there is a point in which supply and demand intersect each other, this is where the quantity of demand equals the quantity supplied, this is the ideal price that retailers and producers should set their prices, it is known as the point of equilibrium, labelled in the diagram. Theoretically, the market will reach the equilibrium point without intervention. When consumers want more of a product, the producers, driven by the incentive of a profit, will aim to meet the expectations of the consumer’s demand, this is called an excess in demand.
Also, when consumers buy less of a product, producers will supply fewer units called an excess in supply. This principle is known as the price mechanism. However, the price mechanism is not always successful in determining the right price for a good or service. When the price mechanism fails to achieve the desired outcome, it is called market failure, examples where this is likely to occur is in inelastic goods such as electricity and water, no matter how much firms are willing to charge for these utilities, consumers ill always need to pay for it because they are necessities in life. In order to resolve market failure, governments will often intervene to stop businesses from exploiting consumers, in the example mentioned before governments will often interfere through setting a type of price intervention, called a price ceiling. Price intervention refers to the setting a maximum or minimum price for a particular commodity that firms must abide by, a price ceiling is the maximum price businesses may charge for a commodity.
Price ceilings are set up to prevent businesses, that consumers rely on for survival from abusing the fact that the market can’t persist without them, and as a result the business decides on charging ridiculous amounts for its product. Another example of where the price intervention may need to interfere when businesses are imposing on individuals is in the price of labour. In Australia, there is a system of where employers must not pay their workers wages below a specific amount (minimum wage). Currently the minimum wage for a full time adult is $15. 6 per hour, this means that the minimum an employer is legally allowed to pay their workers in $15. 96 per hour, if they go below this then workers have grounds to make a complaint and increase their wage. This is a form of price intervention called price floors, unlike price ceilings, price floors set the minimum price for a good or service, in the example that service is human labour. The government imposes price floors on labour through the use of industrial awards, these awards set out the minimum wage and the bare necessities to a safe working environment.
Awards are required to prevent a situation like that in India, where workers are paid scarcely enough to live on while having to work like slaves just to make ends meet. These awards prevent the standard of living from going too low, Australia is ranked second based on the Human Development Index, India is ranked 136th, this ranking would undoubtedly be affected if government intervention in the form of industrial awards took place in an attempt to raise living standards.
In summary, price intervention is a government imposed restriction on the vertical, price axis, taking the form of a price ceiling (right), where the government sets the maximum amount a product can be sold form, or price ceilings (left) where instead of being the maximum, it is the minimum amount a product can be sold for. These are both limitations on price, however the government can also place restrictions on quantity, this is discussed further. Unlike price intervention, the use of quantity intervention aims to influence the amount of particular good or service provided by the market.
The government targets products that are produced in proportions that are either too low or too high, because individual business firms and consumers to not take into consideration the social costs and benefits, related to the production and consumption of that product. These social costs and benefits are referred to as externalities. Externalities occur when the firm or individual making a decision does not have to pay for, or does not receive the full consequences of that decision. Externalities are broken into two categories; negative externalities and positive externalities.
Negative externalities are the costs that the producer or consumer does not pay have to pay for, instead society as a whole pays for it. For example, when a manufacturing business produces its wares, carbon dioxide and other pollutants are released into the atmosphere. The pollution is the negative externality. The business does not consider the cost that pollution could have on society, but only considers factors explicitly relevant to themselves and their own performance. So, instead of the business paying for the environmental costs, society is left to deal with it.
This is where governments intervene through the use of taxes. Take the Carbon Tax for example, the government has tried to control negative externalities of private businesses through placing a tax on carbon emissions. Another example of the government controlling negative externalities is through tariffs, an externality of importing goods could be that local businesses loose revenue resulting in higher unemployment rates, tariffs deal with this by levelling the ‘playing field’ and increasing the price of imports.
On the other hand, positive externalities occur when the firm does not receive the full benefit of their decisions, in other words, the benefit to the firm or individual is less than the benefit to society in general. An example of a positive externality is beekeeping, in addition to the owner of the bees getting honey, the bees will also pollinate surrounding plants, hence helping surrounding farms. In this situation the pollination of crops not owning the beekeeper, is the positive externality.
In order to increase positive externalities, governments can provide a subsidy to support that industry, and consequentially increase the amount that particular industry produces, which, in turn will support those industries that benefit from the positive externalities. In conclusion market equilibrium is a circumstance where all supply meets the exact value of all demand, there is no excess. However the economy does not always produce the desired outcomes by itself.
Governments intervene with the market to correct market failures and to achieve an economy that is closer to equilibrium. The government can use a number of different methods of intervention, being; price intervention in the form of price floors and price ceilings, as well as quantity intervention by attempting to control externalities through the use of taxes and tariffs on negative externalities and offering subsidy for industries that yield positive externalities.