What this lesson teaches
I can describe taxes, subsidies, price controls and quotas as ways a government intervenes in a market.
Syllabus 9570, 2.1.3(a). Government Intervention in Markets: Governments may intervene in markets in the form of taxes, subsidies, price controls (maximum and minimum prices) and quantity controls (quotas)
Make a guess
COE premiums jump after the quota is cut. Who receives the higher premiums that bidders pay?
- The government, because it auctions the COEs.
- Car dealers, who raise their profit margins.
- Car makers abroad, who now sell fewer cars.
Show the answer
The government, because it auctions the COEs.
When permits are auctioned, the gap between what buyers pay and what sellers would accept goes to the government.
A quota caps quantity, so the price rises until buyers want only the permitted amount.
A quota is a legal limit on the quantity that can be produced, sold or imported in a period.
If the quota is below the equilibrium quantity, supply becomes vertical at the quota. Buyers who want more than the quota compete for it, and the price rises until quantity demanded equals the quota.
Singapore's COE system is a quota on new vehicle registrations. The Land Transport Authority sets how many COEs are available, and bidding sets the premium. When demand for cars rises and the quota is fixed, the whole effect falls on the price.
Who gains from the higher price depends on who holds the permits. If the government auctions them, as with COEs, the government collects the gap.
- Effect
- Quantity fixed; price rises to where demand meets the quota.
- Singapore
- COE quotas on new vehicle registrations.
- Who gains
- Whoever holds the permits, or the government if it auctions them.
Worked example: A 40-unit daily limit
Without a quota, 80 units a day sell at $6. The government allows only 40 a day.
- At 40 units, buyers are willing to pay $8 each, so the price rises to $8.
- Sellers would have supplied the 40th unit for $4.
- Buyers spend $8 x 40 = $320 a day.
- If permits are free, sellers keep the $4 gap on each unit. If the government auctions the permits, it collects up to $4 x 40 = $160.
Watch out for this
A quota is a way of capping the price.
A quota caps quantity. With less available, the price usually rises.
Check your understanding
Demand for cars rises while the COE quota stays the same. What happens?
- Premiums stay the same, but buyers wait longer in a queue for each COE.
- More COEs are issued, because the quota rises in line with demand.
- COE premiums rise, and the number of new COEs stays the same.
Show the answer
COE premiums rise, and the number of new COEs stays the same.
Right. With quantity fixed by the quota, the rise in demand shows up entirely as a higher price.