Mixed economic system

In the middle of a housing shortage, a city caps rents so that ordinary families can afford a flat. Within a few years there are fewer flats to rent than before, waiting lists are longer, and the lucky tenants who hold a cheap lease never move. Nobody intended that outcome. Every tool a government uses to fix a market works by changing prices or quantities, and each one has side effects that follow as predictably as the effect it was meant to have. Knowing both is the whole of this topic.

A mixed economy tries to keep the strengths of markets while correcting their failures. Its advantages are that the private sector still responds to consumer demand and competition still pushes firms to be efficient, while the government can provide public goods, encourage merit goods, discourage demerit goods, deal with external costs and reduce inequality. Its disadvantages come from the government side: intervention can be costly to run, it needs taxes that may weaken incentives, officials may lack the information to intervene well, and a policy can create new problems of its own. Where the line between market and state is drawn differs from country to country, and that choice is what the rest of this note is about.

Price controls

A maximum price only has an effect if it is set below the equilibrium price. At the lower price more people want to buy the good and firms want to sell less of it, so quantity demanded exceeds quantity supplied and a shortage appears. Because price is no longer allowed to ration the good, something else has to: queues, waiting lists, first come first served, or sellers choosing their favourite customers. Some buyers who cannot get the good legally will pay more for it illegally, so a black market often grows alongside a maximum price. Governments use maximum prices on essentials such as rented housing, bread or fuel, where the aim is to protect people on low incomes.

A minimum price works the other way round. Set above equilibrium, it makes firms want to supply more and consumers want to buy less, so a surplus appears. Minimum prices are used to guarantee farmers a stable income, in which case the government usually has to buy the surplus and store or destroy it, and to discourage harmful goods, such as a minimum price per unit of alcohol, where the aim is to make the cheapest and strongest drinks dearer. A national minimum wage is a minimum price for labour, and the same diagram applies to it.

Taxes and subsidies

An indirect tax raises the cost of supplying each unit, so the supply curve shifts to the left, the price rises and the quantity bought falls. Governments use indirect taxes on demerit goods such as cigarettes, alcohol and sugary drinks, and on goods with external costs such as petrol, to reduce consumption and raise revenue at the same time. The advantages are that the tax discourages the harmful activity, raises money that can be spent on the damage, and leaves consumers free to choose. The disadvantages are that it falls hardest on people with low incomes, that it changes consumption very little when demand is inelastic, and that a high tax can encourage smuggling.

A subsidy has the opposite effect to a tax: it lowers producers' costs, so the supply curve shifts to the right, the price falls and the quantity bought rises. Subsidies are used to encourage merit goods such as public transport, vaccinations and renewable energy, and to keep essentials such as food affordable. They make the good cheaper and increase its use, but they cost the government money that must be raised elsewhere, they can keep inefficient firms in business, and once a subsidy exists it is politically difficult to remove.

Other ways governments intervene

Regulation is a set of rules backed by law: bans on smoking in public places, minimum safety standards, limits on pollution, age limits on buying alcohol. It is quick and certain in its effect, but it has to be enforced, which costs money, and a firm that can gain from breaking a rule may do so if the chance of being caught is low. Direct provision means the government supplies a good itself, usually free at the point of use, as with state schools, public hospitals, street lighting and defence. It guarantees that public goods and merit goods are available to everyone, but it is paid for through taxes and, without competition, may be run inefficiently.

Nationalisation is the transfer of a firm or industry from private to state ownership. It lets the government run the industry in the public interest, which is why it is used for natural monopolies such as water supply or rail networks, but state firms face no profit motive and can become inefficient. Privatisation is the reverse, the sale of a state-owned firm to the private sector. The profit motive and, where it exists, competition can push the firm to cut costs and improve service, but a privatised monopoly may simply charge higher prices unless it is regulated. Quotas are limits on the quantity that can be produced or used, such as fishing quotas or limits on the extraction of oil and minerals, which protect a natural resource from being used up too quickly.