Edexcel A-Level Economics A (9EC0) · Theme 1
Specification points
- Methods of intervention: indirect taxes, subsidies, price controls, tradable permits, provision, regulation and information.
- The impact of intervention on markets and stakeholders.
- Government failure and its causes.
Correcting market failure
Governments intervene to correct the market failures in Theme 1.3, aiming to move output towards the social optimum.
| Method | Targets | Effect |
|---|---|---|
| Indirect tax | Negative externalities/demerit goods | Raises cost, reduces output; internalises external cost |
| Subsidy | Positive externalities/merit goods | Lowers cost, raises output |
| Maximum price | Affordability | Below equilibrium → shortage |
| Minimum price | Producer/worker protection | Above equilibrium → surplus |
| Tradable pollution permits | Pollution | Cap total emissions; market sets the price |
| State provision | Public/merit goods | Direct supply funded by taxation |
| Regulation | Various | Standards, limits and bans |
Key definitions
| Term | Definition |
|---|---|
| Tradable permit | A licence to emit a set amount of pollution, which firms can buy and sell. |
| Government failure | When intervention creates a net welfare loss, worse than the market failure it aimed to fix. |
| Regulation | Rules that control the behaviour of firms and consumers. |
Evaluating intervention
Each method has trade-offs. Taxes need the external cost measured accurately; subsidies have an opportunity cost; price controls create shortages or surpluses; permits need a well-set cap. Effectiveness also depends on elasticity — an inelastic demand means a tax changes quantity little.
Government failure
Government failure occurs when intervention makes the allocation of resources *worse*. Causes include:
- Distortion of price signals (e.g. subsidies encouraging over-production).
- Unintended consequences (black markets from price controls).
- Information gaps — governments may not know the true external cost.
- Administrative and enforcement costs, and the risk of regulatory capture.
Intervention should be judged against the risk of government failure, not an ideal outcome.
Worked example
A city introduces tradable pollution permits with a strict cap. Firms that cut emissions cheaply can sell spare permits to those for whom cutting is expensive, so total pollution falls at least cost. But if the cap is set too loosely, permit prices collapse and little pollution is cut — government failure.
Common exam mistakes
- Presenting a policy as a perfect solution — always evaluate.
- Ignoring elasticity when judging a tax or subsidy.
- Forgetting government failure as a key evaluation point.
Exam technique
For every intervention, analyse the intended effect with a diagram, then evaluate by elasticity, cost, information and the risk of government failure.
Quick revision
- Methods: taxes, subsidies, price controls, permits, provision, regulation, information.
- Effectiveness depends on elasticity and accurate information.
- Government failure = intervention that worsens welfare.