The mixed economy: privatisation, taxes, subsidies and price controls

Last time

Before we start: last time, in The market economic system and the price mechanism, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

The government steps in

In a mixed economy, the government steps in where the market fails. It can own firms, provide goods, tax, subsidise, fix prices, regulate and ban. Each tool works in a different way, and each has a cost. In this lesson we take them one at a time, with a diagram for each.

The mixed economy

A mixed economy has a private sector, owned by individuals and firms, and a public sector, owned by the government. The government provides public goods and many merit goods, and uses taxes, subsidies and laws to change what the private sector does. The aim is to keep the strengths of the market, such as choice and efficiency, and correct its failures.

Privatisation and nationalisation

Privatisation is the sale of state-owned firms or assets to the private sector. The mark scheme gives one mark for state-owned and one for to the private sector. Nationalisation is the opposite: the government takes a private firm into public ownership. Privatised firms face the profit motive and competition, which may raise efficiency. But they may cut jobs, or raise prices if they become monopolies.

Indirect taxes

An indirect tax is a tax on spending, such as a sales tax on cigarettes. It is paid to the government by the seller. It raises the firm's costs, so supply falls and the supply curve shifts left. The price rises and the quantity bought falls. This is how a tax discourages a demerit good.

A tax on the diagram

Before the tax, the market is at E: a price of 5 dollars and 5 units. The tax shifts supply from S to S1. The new equilibrium is a price of 6 dollars and a quantity of 4. The good is dearer, and less of it is consumed.

Subsidies

A subsidy is a payment by the government to producers, to lower their costs. It might go to bus companies or to schools. Lower costs mean supply rises, and the supply curve shifts right. The price falls and the quantity bought rises, so more of a merit good is consumed.

A subsidy on the diagram

The subsidy shifts supply from S to S1. The price falls from 5 dollars to 4 dollars, and the quantity rises from 5 to 6.

A maximum price

A maximum price is a legal ceiling: the price may not go above it. To have an effect, it is set below the equilibrium, here at 3 dollars. At 3 dollars, buyers want 7 units but sellers offer only 3, so there is a shortage of 4. Governments use it to keep basic foods, such as flour, affordable.

A minimum price

A minimum price is a legal floor: the price may not fall below it. It is set above the equilibrium, here at 7 dollars. At 7 dollars, sellers offer 7 units but buyers want only 3, so there is a surplus of 4. A minimum wage and guaranteed crop prices for farmers are examples.

Regulation, bans and state provision

Regulation sets rules: limits on pollution, safety standards, and age limits on buying cigarettes. Firms that break them are fined. A ban stops a harmful product altogether, such as certain drugs. But bans can create illegal markets. State provision means the government supplies the good itself, often free, as with public schools, hospitals and roads.

Every tool has a cost

Taxes raise prices, which can hurt people on low incomes, and the government may set the tax at the wrong level. Subsidies have an opportunity cost: the money could have been spent on something else. Firms may also become inefficient. Price controls create shortages or surpluses, and regulation costs money to enforce. That is why discuss questions need both sides.

Mistakes that lose marks

Mistake one: saying a tax shifts demand. An indirect tax raises costs, so it shifts supply. Mistake two: drawing a maximum price above the equilibrium. Then it has no effect at all. Mistake three: defining privatisation as a private firm getting bigger. It is a sale from the public to the private sector. The fix: name which curve moves, and where the new price ends up.

The full-marks tip

The full-marks tip: for a tax or subsidy, say it changes costs, so supply shifts, then give the new price and quantity. For a price control, say where it is set, and whether it causes a shortage or a surplus.

On one card

So, on one card: government intervention in markets. Keep it for revision.