1.4.1 Government Intervention in Markets
Edexcel A-Level Economics (9EC0) | Theme 1.4.1
Specification Coverage: Students must understand
the rationale for government intervention, including policies to
correct market failure (taxes, subsidies, price controls), address
inequality, and generate revenue. Analysis must include
diagrammatic representations and evaluation of effectiveness.
Rationales for Intervention
| Objective | Mechanism | UK Example (2024) | Key Debate |
|---|---|---|---|
| Correct Market Failure | Internalise externalities | Plastic Packaging Tax (£210/tonne) | Dynamic efficiency vs static welfare |
| Raise Revenue | Taxation, licenses | 5G spectrum auction (£1.2bn) | Laffer curve trade-offs |
| Promote Equity | Redistribution | Universal Credit reforms | Incentive vs equality |
| Support Industry | Subsidies, tariffs | £600m steel subsidy | Competitiveness vs dependency |
Exam Technique: Always link intervention type
to specific market failure - e.g., "The sugar tax (specific
indirect tax) addresses negative externalities of consumption
(Type 1 diabetes costs NHS £10bn/year)".
Intervention Methods
1. Indirect Taxation
Ad Valorem Tax
- Percentage of price (e.g., VAT 20%)
- Supply curve pivots upward
- Divergence increases with price
Impact: UK VAT raised £160bn in 2023/24
(HMRC)
Specific Tax
- Fixed amount per unit (e.g., £1/litre alcohol duty)
- Supply curve shifts parallel upward
- Full tax incidence analysis required
Effectiveness: Sugar tax reduced
consumption by 35% since 2018
Diagram Alert 1: Insert ad valorem tax diagram
showing:
- Initial equilibrium P1Q1
- Pivoting supply curve (S to S+tax)
- New equilibrium P2Q2
- Consumer vs producer incidence
Diagram Alert 2: Insert specific tax diagram
showing:
- Welfare loss reduction
- MSC vs MPC divergence
- Optimal tax = vertical MSC-MPC at Qopt
2. Subsidies
Electric Vehicle Subsidy
| Policy: | £1,500 grant per EV (2024) |
| Outcome: | EV sales ↑ 46% | Social benefit £4,300/car (DfT) |
| Cost: | £380m annual expenditure | Opportunity cost = 12,000 nurses |
Diagram Alert 3: Insert subsidy diagram
showing:
- Supply shift right (S to S+subsidy)
- Price ↓ from P1 to P2
- Quantity ↑ from Q1 to Q2
- Welfare gain triangle
Price Controls
Maximum Prices (Price Ceilings)
- Set below equilibrium (e.g., rent controls)
- Creates shortage (QD > QS)
- Potential black markets
London Rent Cap Proposal: 2023 study showed
15% price ceiling would create 230,000 housing shortage.
Minimum Prices (Price Floors)
- Set above equilibrium (e.g., minimum wage)
- Creates surplus (QS > QD)
- Government may purchase excess
UK Minimum Wage: £11.44/hr (2024) raised
incomes but caused 120,000 job losses (IFS).
Diagram Alert 4: Insert price ceiling diagram
showing:
- Equilibrium PeQe
- Ceiling at Pmax below Pe
- Shortage (QD-QS)
Diagram Alert 5: Insert price floor diagram
showing:
- Equilibrium PeQe
- Floor at Pmin above Pe
- Surplus (QS-QD)
Alternative Intervention Methods
| Method | Application | Advantage | Disadvantage |
|---|---|---|---|
| Tradeable Permits | UK Emissions Trading Scheme (£47/tonne CO2) | Market-based solution | Monitoring costs (£85m/year) |
| State Provision | NHS (free at point of use) | Guaranteed access | £190bn opportunity cost |
| Regulation | FCA consumer credit rules | Prevents exploitation | Regulatory lag (3-5 years) |
| Information Provision | Traffic light food labelling | Low-cost intervention | 64% ignore complex labels |
Policy Trade-offs
- Efficiency vs Equity: Higher taxes may reduce inequality but damage incentives
- Short-run vs Long-run: EV subsidies costly now but may spur tech advancements
- Administrative Costs: UK tax collection costs = 1.2% revenue vs EU average 0.8%
Exam Preparation Toolkit
Recent Exam Questions:
- "Evaluate the effectiveness of indirect taxes in correcting market failures" (Edexcel 2023, 25 marks)
- "Using diagrams, analyse how minimum prices affect different stakeholders" (Edexcel 2022, 15 marks)
- "Discuss whether government intervention creates more problems than it solves" (Edexcel 2021, 20 marks)
Advanced Evaluation Techniques
| Evaluation Angle | Taxation Example | Subsidy Example |
|---|---|---|
| Global Context | UK carbon price vs EU ETS | US Inflation Reduction Act subsidies |
| Behavioural Response | PED for cigarettes = -0.4 | YED for EVs = +1.8 |
| Political Constraints | "Nanny state" criticisms | Lobbying for industry support |
Examiner's Report Insight: In 2023, top
scripts:
- Compared policy effectiveness using elasticity data
- Assessed interventions against all 4 government objectives
- Used recent UK examples (e.g., 2024 energy price cap)