How Does Government Policy Impact Microeconomics?

Government policy has microeconomic effects whenever its implementation alters the inputs and incentives for individual economic decisions. These changes come in many forms, including tax policy, fiscal policy, regulations, tariffs, subsidies, legal tender laws, licensing, and public-private partnerships (to name a few). These policies manipulate the costs and benefits that individual actors face in nearly every facet of modern life.

Key Takeaways

  • Government policy influences microeconomics by implementing incentives and inputs that shape individual decisions.
  • Government interventions can come in the form of tax policy, fiscal policy, interest rate policy, regulations, tariffs, and subsidies, among others.
  • These government policies give structure to the economic costs and benefits that citizens experience in their day-to-day lives. 

Intentional and Unintentional Consequences

Sometimes the impacts of government policy are intentional. The government might provide a subsidy to farmers to make their businesses more profitable and encourage farm production. Conversely, the government might put a tax on cigarettes and alcohol to discourage behavior that it doesn't approve of. Other impacts are unintentional.

When the U.S. government propped up wages during the Great Depression, for example, it unintentionally made it unprofitable for individual firms to hire extra employees.

The nature of these causes can be understood by identifying the forces behind microeconomic decisions.

Important Concepts in Microeconomics

The models in microeconomics study the interaction of supply and demand within individual markets and specific actors. If a government policy mandates an artificially high minimum wage and subsequently leads to greater unemployment, microeconomics describes how the floor on labor costs changes inputs for firms. It is not concerned with measuring the aggregate level of unemployment in the entire economy.

How Government Policy Changes Microeconomic Factors

Even the existence of a non-voluntary government has microeconomic impacts. Governments are financed through taxes, which must be taken from private actors. When this happens, individuals and businesses must either spend less income or work and produce an additional amount to offset the impact of the taxes.

Governments can also alter markets when they decide to spend money. Any individuals or businesses that receive government funds receive, in effect, a wealth transfer from every other taxpayer. If a business receives a subsidy from the government, it produces at a higher cost curve than is possible without the subsidy. All other actors that might have received those funds (were it not for the taxation and subsidy) have correspondingly less income or revenue.

Fiscal policy directly impacts prices. When the government spends $1 million purchasing computers, it bids up the price of computers in the short run. This crowds out other individuals who are subsequently priced out of the market. The same effect occurs when the government issues bonds and crowds out other borrowers. This crowding out becomes even more disruptive when the government directly provides services and employs workers.

The Bottom Line

Governments either change the quantity of a good available (supply) or the number of funds that can be directed toward those goods (demand). Governments can also make some forms of trade illegal or make them illegal under certain contexts. All of these impact the choices that microeconomic actors face and change their decision-making processes.