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Government Policies and Consumer Demand

Discuss how a government’s policies toward income and wealth distribution can affect a consumer’s demand.

Category:

Public Finance and Government Intervention

[CIE A level November 2019]

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Answer


Step ➊ : Define ‘income’ and ‘wealth’ in the introduction.


In order to reduce inequality in the distribution of income and wealth, several policies are adopted by the government. First, it is important to distinguish between income and wealth. Income is the reward for the services of a factor of production, for example, wages and salaries for labour whereas wealth is the accumulation of a stock of assets such as property, bonds or bank accounts.


Step ➋ : Explain the impact of taxation on income and wealth.


The tax system can be used in order to reduce inequalities in income and wealth. Progressive income taxes can be used. Those earning higher incomes can be taxed a higher percentage of their income than those on lower incomes.


Step ➌ : Explain the impact of transfer payments on income and wealth.


The government may means-tested in order to redistribute income and wealth. Means-tested benefits are only paid to those on low incomes. Examples include unemployment benefits.


Step ➍ : Explain the impact of policies on consumer’s demand for normal goods


A better distribution of income implies that the income gap between the rich and the poor will be reduced. This means that the less wealthy will get a rise in income and a better purchasing power. For example, an increase in income for the unemployed means that they will be able to afford more goods and services. An increase in income is represented by a parallel shift outwards of the budget line from B1 to B2. The consumer to choose a better combination of normal goods A and B.

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It should also be noted that high-income earners may be earning less following income and wealth policies such as progressive taxation. They will experience an inward shift in their budget line. They will consume less of normal goods.

There will be an increase in demand for normal goods following an increase in income for the poor. If the budget constraint rises to B2, then the consumer will increase consumption of good A and also of good B, albeit to a lesser extent. E2 is the new optimal position, where more of both goods are being consumed. The change in position from E1 to E2 is what occurs when both goods are normal goods.

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Step ➎ : Explain the impact of policies on consumer’s demand for inferior goods.
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If by contrast, good X were an inferior good, such as cheap margarine, its demand would fall as income rose; its income elasticity of demand would be negative. This is illustrated in the figure below . Again, an increase in income is represented by a parallel shift outwards of the budget line. Point b is to the left of point a, showing that at the higher income B2, less X is purchased

It should also be noted that high income earners may be earning less following income and wealth policies such as progressive taxation. They will experience an inward shift in their budget line. They will consume more inferior goods.

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Step ➏ : Conclude
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To conclude, policies towards income and wealth will reduce the gap between the rich and the poor. There will be an increase in the income for the poor. They will experience an outward shift in the budget line. They will consume more of normal goods such as clothing and less of inferior goods such as cheap margarine. Conversely, those earning higher incomes may be taxed more and experience an inward shift of the budget line. They may consume less of normal goods and more inferior goods.

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♕ Marking scheme
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A consideration of the impact of taxation, government transfer payments and/or other government policies on income and wealth and hence the budget line and demand. Consideration of the effect of taxation on wealth and the consumption effects of changes in wealth. Consideration of the difference in the income effect for normal and inferior goods.

L4 (9–13 marks): For a response that explains two policies and their impact on income and wealth linked to consumer demand for normal goods and inferior goods. (No conclusion maximum 11).

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