Syllabus points
- Explain price controls: maximum and minimum prices.
- Explain indirect taxes and subsidies and their effects.
- Explain direct provision and the effects of intervention on stakeholders.
Why governments intervene
Even competitive markets may produce outcomes society dislikes — prices too high for essentials, too low for producers, or harmful goods over-consumed. Governments intervene using price controls, taxes, subsidies and direct provision.
Price controls
| Control | Set where | Effect |
|---|---|---|
| Maximum price (price ceiling) | Below equilibrium | Creates a shortage; helps consumers but rationing/black markets appear. |
| Minimum price (price floor) | Above equilibrium | Creates a surplus; helps producers but government may buy the excess. |
- A maximum price (e.g. rent controls) keeps essentials affordable but excess demand leads to queues, black markets or falling quality.
- A minimum price (e.g. agricultural support or a minimum wage) protects producers/workers but causes surpluses (unsold goods or unemployment).
Indirect taxes and subsidies
- An indirect tax raises firms' costs, shifting supply left. Price to consumers rises and quantity falls. The tax burden (incidence) is split between consumers and producers depending on elasticity — the more inelastic side bears more.
- A subsidy lowers costs, shifting supply right. Price falls and quantity rises; the government bears the cost.
Tax incidence: the more inelastic side of the market pays the larger share of the tax.
Key definitions
| Term | Exam-ready definition |
|---|---|
| Price ceiling | A legal maximum price below equilibrium. |
| Price floor | A legal minimum price above equilibrium. |
| Tax incidence | How the burden of an indirect tax is shared between consumers and producers. |
| Subsidy | A government payment to producers to lower costs and raise output. |
Worked example
A government taxes sugary drinks. Supply shifts left, price rises and quantity falls, reducing consumption. Because demand is fairly inelastic (habit), consumers bear most of the burden and the tax raises significant revenue — which can fund health programmes. Critics note it is regressive and may push consumers to untaxed substitutes.
Common exam mistakes
- Drawing a maximum price *above* equilibrium (it must be below to bind).
- Ignoring who bears the tax — always link incidence to elasticity.
- Forgetting the government's budget cost of a subsidy.
Exam technique
Evaluate every intervention by stakeholder: consumers, producers, government and society. Weigh intended benefits against unintended effects (shortages, surpluses, black markets, opportunity cost of spending).
Quick revision
- Max price → shortage; min price → surplus.
- Indirect tax shifts S left; subsidy shifts S right.
- Tax incidence falls more on the inelastic side.