Microeconomic Policies: Government Intervention & Market Effects

Understanding Microeconomic Policies & Government Roles

Defining Microeconomic Policy

Microeconomic Policy: A set of measures and actions undertaken by the government concerning microeconomics, examining how markets function.

Market Regulation and Competition Conditions

The state is responsible for:

• Guaranteeing Property Rights: Through laws, judicial systems, police, and defense.
• Defending Competition: Reducing market power and maximizing existing competition.
• Correcting Information Asymmetry: Setting minimum quality standards to improve market transparency.
• Correcting Externalities: For example, by setting maximum production limits.

Modifying Exchange Conditions

Government actions can alter market exchanges:

• Buyer Incentives: Granting aid or subsidies (e.g., for home purchases) to increase demand, potentially boosting supply.
• Industrial or Supply Policies: Measures intended by the administration to strengthen and guarantee the existence of a competitive supply. This includes facilitating investment in new technologies through subsidies, improving market functioning, enhancing infrastructure, and facilitating the restructuring of uncompetitive industries.
• Pricing Policies:
  • Price Ceilings: Implemented when an economic sector has high fixed costs and tends towards a natural monopoly.
  • Minimum Prices: The state may fix prices above the level that would occur in perfect competition.

Opportunity Cost of Microeconomic Policy

Implementing microeconomic policies involves an opportunity cost, as resources used for one policy cannot be used for others.

Related Economic Policies

• Fiscal Policy: Has an effect on public revenue and expenditure.
• Monetary Policy: Controls the monetary and financial conditions of the economy, such as interest rates, credit availability, etc.
• Exchange Rate Policy: Impacts the value of the nation's currency, potentially lowering the cost of national products relative to foreign competition.

Wagner's Law

Wagner's Law: Explains the trend towards growth in public expenditure in developed countries.

Taxation Fundamentals

What is a Tax?

A tax represents compulsory payments legally required from subjects (individuals or entities) as specified by law.

The Budget

A budget is an accounting document that contains the list of planned government expenses and revenues for a specified period.

Principles of Taxation

Key principles for designing a tax system:

• Equity: Aims for a fair tax system, often considering:
  • The Benefit Principle: Taxes paid should relate to the benefits received from public services.
  • The Ability-to-Pay Principle: Taxes paid should relate to an individual's capacity to pay.
• Neutrality: Taxes should minimally interfere with the free functioning of markets.
• Simplicity: The tax system should be simple and uncomplicated to administer and comply with.

Types of Taxes

• Direct vs. Indirect Taxes:
  • Direct Taxes: Levied directly on the income or wealth of individuals or corporations (e.g., income tax, corporate tax).
  • Indirect Taxes: Levied on goods and services or transactions (e.g., sales tax, Value Added Tax - VAT).
• Tax Rate Structures:
  • Proportional Tax: The tax rate is constant regardless of the income level (e.g., a flat 10% tax).
  • Progressive Tax: The average tax rate increases as income increases (higher earners pay a larger percentage of their income).
  • Regressive Tax: The average tax rate decreases as income increases (lower earners pay a larger percentage of their income).

Rationale for Government Intervention

Governments intervene in the economy for several reasons:

• To establish and enforce the rules of the game (laws and regulations).
• To achieve economic efficiency when market failures occur (e.g., externalities, public goods).
• To achieve a more equitable and cohesive society (e.g., income redistribution).
• To smooth excessive fluctuations of macroeconomic variables (stabilization).
• To act as a supplier (bidder) of public goods and services.

Other Government Economic Actions

Privatization

Privatization: The sale of state-owned enterprises or assets, or the transfer of participation held by public administrations in certain companies, to the private sector.

Public Sector Debt

Public Sector Debt: Arises when the government borrows money, often by issuing securities like treasury bills or bonds.