The lesson
Explain the mechanism, then qualify the outcome. Use this page as a fast, high-quality revision pass—not a wall of notes to memorise.
External costs and benefits
A market price reflects private costs and private benefits. Market failure arises when people outside the transaction are affected but that effect is not priced in.
- Social cost = private cost + external cost.
- Negative production or consumption externalities can lead to over-allocation of resources.
- Positive externalities can lead to under-consumption or under-production relative to the social optimum.
Intervention needs evaluation
A tax, subsidy, regulation or information campaign can change incentives, but a strong answer explains why the policy may be difficult to implement.
- Taxes can make polluters face more of the cost their activity creates.
- Subsidies can reduce the price of goods with wider benefits, such as education or vaccination.
- Evaluate measurement, enforcement, equity, government failure and unintended consequences.
Worked exam thinking
Worked example: congestion charge
Prompt: Why might a city charge drivers to enter a congested area?
How to turn knowledge into marks
Use this answer route
For a focused explanation or short evaluation question on this topic:
- 1Define the core idea precisely.
- 2Explain the chain of cause and effect.
- 3Apply it to the context in the question.
- 4Evaluate a limitation, trade-off or condition.
Quick questions
Check your understanding
What is market failure?
It is when market forces do not allocate resources in a way that maximises social welfare.
What is the difference between private and social cost?
Private cost is borne by the producer or consumer. Social cost includes private cost plus any external cost imposed on third parties.
Why might a subsidy be used?
It can encourage consumption or production where private decisions ignore wider social benefits.