IB DP Economics: Role of government in microeconomics – Revision Notes

These notes follow the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. The subject is sub-topic 2.7, Role of government in microeconomics, at SL and HL. Two items are HL only: the calculation of effects on markets and stakeholders, and consumer nudges. Longer explanations are in the study guide; test yourself with the practice set.

All markets and figures below are fictional. Related pages: the course hub for IB DP Economics, a checklist to print, and some free 10-minute diagnostics. Equilibrium basics are in the demand, supply and equilibrium revision notes.

Reasons for intervention (list of seven)

Learn the seven aims, then pair each with a tool and an example.

Aim	Typical tool
Earn government revenue	Indirect tax
Support firms	Subsidy, price floor
Support low-income households	Price ceiling, subsidy, direct provision
Influence level of production	Tax (down), subsidy (up)
Influence level of consumption	Tax (down), subsidy (up), nudge (HL only)
Correct market failure	Tax, subsidy, regulation
Promote equity	Direct provision, subsidy, ceiling

Forms of intervention at a glance

Tool	Curve or line	Effect on price paid	Effect on quantity	Key side-effect
Price ceiling (below Pe)	Horizontal line below Pe	Falls	Falls to Qs	Shortage, black market
Price floor (above Pe)	Horizontal line above Pe	Rises	Traded falls to Qd	Surplus
Indirect tax	S shifts up by the tax	Rises	Falls	Revenue; welfare loss
Subsidy	S shifts down by the subsidy	Falls	Rises	Cost to government
Direct provision	Government supplies the service	Often free or low	Rises	Taxpayer cost
Command and control	Rule, limit or ban	Varies	Often falls	Enforcement cost
Consumer nudge (HL only)	Changes how choices appear	Unchanged	Behaviour shifts	May be weak or manipulative

Must-know distinctions

• Ceiling versus floor. A ceiling is a maximum price and needs to be below equilibrium to bind. A floor is a minimum price and needs to be above equilibrium to bind.
• Shortage versus surplus. Shortage means Qd > Qs. Surplus means Qs > Qd.
• Quantity traded under a ceiling is Qs (the short side). Quantity traded under a floor is Qd (the short side) unless the government buys the surplus.
• Tax versus subsidy. A tax moves supply up; a subsidy moves it down. Demand stays where it is.
• Price paid versus price received. With a tax, consumers pay the new equilibrium price and producers keep that price minus the tax. With a subsidy, producers receive the new price plus the subsidy.
• Direct provision versus command and control. One supplies a service; the other sets rules.

Method: drawing the diagram

1. Axes: price (vertical), quantity (horizontal).
2. Draw D and S; label Pe and Qe.
3. Add the intervention (line or shifted S, labelled S + tax or S + subsidy).
4. Mark the new quantity and the prices paid and received.
5. Shade any revenue, cost or welfare loss, and label it.

Method: HL calculations (HL only)

1. Write demand and supply in the same form (P in terms of Q, or Q in terms of P).
2. Find the free-market equilibrium.
3. Apply the intervention: replace P by (P − tax) in supply for a tax, by (P + subsidy) for a subsidy; use the ceiling or floor price directly.
4. Solve for the new quantity and prices.
5. Compute the effects asked for: revenue, spending, government cost or revenue, shares of the tax, welfare loss.
6. Check that the pieces add to the total.

The guide does not name which quantities to compute, so practise all of them.

Worked reminder: indirect tax (fictional, HL only)

Market for sparkling water in Brenmoor: demand P = 200 − 4Q, supply P = 20 + 2Q. Tax: 18 cu per bottle.

Before: 200 - 4Q = 20 + 2Q  ->  Q = 30, P = 80
After:  200 - 4Q = 38 + 2Q  ->  Q = 27
Consumer price = 200 - 4(27) = 92
Producer keeps = 92 - 18 = 74

• Consumers pay 12 more; producers keep 6 less; 12 + 6 = 18.
• Revenue: 18 × 27 = 486. Consumer share 12 × 27 = 324. Producer share 6 × 27 = 162.
• Welfare loss: ½ × 18 × (30 − 27) = 27.

Worked reminder: price ceiling (fictional, HL only)

Market for bottled gas in Selvane: demand P = 120 − 2Q, supply P = 30 + Q. Equilibrium Q = 30, P = 60. Ceiling: 48 cu.

Demand at 48: 48 = 120 - 2Q  ->  Q = 36
Supply at 48: 48 = 30 + Q    ->  Q = 18
Shortage = 36 - 18 = 18
Demand price at Q = 18: 120 - 36 = 84

Buyers who cannot find gas at 48 cu may pay up to 84 cu on a black market. This is why the ceiling lowers welfare as well as creating a shortage.

Stakeholder summary

Stakeholder	Price ceiling	Price floor	Indirect tax	Subsidy
Consumers	Pay less if they can buy; others go without	Pay more, buy less	Pay more, buy less	Pay less, buy more
Producers	Lower price, lower output	Higher price per unit; may be left with unsold stock	Keep less per unit, sell less	Receive more per unit, sell more
Government	Enforcement cost	Cost if it buys the surplus	Gains revenue	Pays the subsidy
Workers	Jobs may be lost if output falls	May gain if output is supported	May lose hours	May gain hours
Society	Welfare loss; black market	Welfare loss; wasted stock	Welfare loss, but may fix a market failure	Welfare loss, but may fix a market failure

Other forms of intervention: short notes

• Direct provision of services. The government supplies the service itself and pays from taxation. Strength: access for households on low incomes. Limit: opportunity cost of public money, and quality or queues may suffer.
• Command and control regulation and legislation. The rule is set by law, for example a limit on an activity, and breaking it is penalised. Strength: clear and quick. Limit: needs inspection and may be hard to enforce.
• Consumer nudges (HL only). A change in how a choice is framed or set by default. Strength: cheap and keeps freedom of choice. Limit: effects can be small or uncertain, and people may disagree on who decides what is best for them.

When asked to compare two forms, pick one criterion (cost, speed, fairness, effect on choice) and apply it to both throughout.

Evaluation checklist (AO3)

The guide asks you to weigh consequences for markets and stakeholders. Use these prompts.

• Who gains and who loses (consumers, producers, workers, government, wider society)?
• How large is the intervention compared with equilibrium?
• How responsive are demand and supply (steep or flat curves)?
• Short run or long run?
• What are the unintended effects: black market, lower quality, surplus stock, lost jobs?
• What is the cost to taxpayers, and what else could that money do?
• Does the policy meet its stated aim (revenue, support, equity, correcting failure)?

Quick self-test

1. State the position of a price ceiling relative to equilibrium that makes it effective.
2. Which curve shifts for an indirect tax, and in which direction?
3. Name two reasons a government might subsidise a good.
4. Tea in Dunmere: demand P = 90 − 3Q, supply P = 10 + Q. Find equilibrium.
5. (HL only) A floor of 45 cu is set. Find the quantity demanded, quantity supplied and the surplus.
6. (HL only) If the government buys the surplus at 45 cu, what does it spend?
7. Solar panels in Pellaria: demand P = 180 − 3Q, supply P = 40 + Q. Find equilibrium.
8. A subsidy of 24 cu per installation is introduced. Find the new quantity, consumer price and producer price. (HL only)
9. Find the cost to the government and the welfare loss of the subsidy. (HL only)
10. Describe one example of a consumer nudge. (HL only)
11. Give one reason why a subsidy might lower welfare.
12. Give two stakeholders affected by a price floor and one effect on each.

Answers

1. Below the equilibrium price.
2. Supply; upwards (left) by the amount of the tax.
3. Any two of: encourage production, encourage consumption, correct a positive externality, support low-income households.
4. 90 − 3Q = 10 + Q, so 4Q = 80, Q = 20 and P = 30.
5. Qd: 45 = 90 − 3Q gives 15. Qs: 45 = 10 + Q gives 35. Surplus = 35 − 15 = 20.
6. 20 × 45 = 900 cu.
7. 180 − 3Q = 40 + Q, so 4Q = 140, Q = 35 and P = 75.
8. New supply P = 16 + Q. 180 − 3Q = 16 + Q gives 4Q = 164, Q = 41. Consumer price 180 − 123 = 57. Producers receive 57 + 24 = 81.
9. Cost: 24 × 41 = 984 cu. Welfare loss: ½ × 24 × (41 − 35) = 72 cu. Check: consumers gain 18 × 41 = 738, producers gain 6 × 41 = 246, and 738 + 246 = 984.
10. A default option that people may change, such as automatic enrolment in a saving plan.
11. It can push output beyond the level where marginal benefit equals marginal cost, especially where there was no market failure to correct.
12. Farmers (sellers) earn a higher price on each unit sold; consumers face higher prices and purchase fewer units. Taxpayers pay for any stock the state buys.

Where marks are usually lost

• Putting a ceiling over equilibrium or a floor under it.
• Moving demand for a tax or subsidy.
• Missing labels: axes, S and D, Pe, Qe, the new price and quantity.
• Reading the producer price off the wrong curve.
• Forgetting that the shortage or surplus is a gap between quantities, not prices.
• Calculating revenue with the old quantity instead of the new one.
• Describing effects without saying who gains or loses.
• Evaluating by repeating the explanation rather than weighing the effects.
• Showing a final answer with no working when the command term is “calculate”.

Official syllabus

This page follows the IB Diploma Programme Economics guide, sub-topic 2.7 Role of government in microeconomics, first assessment 2022, published by the International Baccalaureate Organization in February 2020.