Government intervention to correct market failure through taxes, subsidies, regulation, price controls, tradable permits and provision, and the causes of government failure.

What this dot point is asking

AQA wants you to explain the main methods of government intervention to correct market failure, evaluate their strengths and weaknesses, and explain the causes of government failure. Evaluation here usually means weighing whether the cure is worse than the disease.

Methods of intervention

• A tax on a negative externality shifts supply left towards the social optimum, ideally set equal to the marginal external cost. It is hard to value precisely and can be regressive (hitting low-income households harder).
• A subsidy on a positive externality shifts supply right, raising consumption towards the optimum, but has an opportunity cost for the budget and may be wasteful if poorly targeted.
• A minimum price set above equilibrium (for example a minimum unit price for alcohol) creates a surplus; a maximum price set below equilibrium (for example a rent cap) creates a shortage and can spawn a black market.
• Tradable permits cap total pollution and let firms buy and sell the right to pollute, so the market reaches the cap at least cost; the difficulty is setting the cap correctly.
• State provision can fully supply public and merit goods, but may be productively inefficient without a profit incentive.

Government failure

Causes include distorted incentives (subsidies that encourage waste), unintended consequences (a black market created by a maximum price, or the EU butter mountains caused by guaranteed minimum prices), information gaps (the government cannot value externalities precisely), administrative and enforcement costs, regulatory capture (regulators acting in the interest of those they regulate), and conflicting policy objectives.

Choosing between the tools

A strong evaluation compares tools rather than treating them in isolation. For a negative externality, a tax internalises the cost and raises revenue but is hard to value and is regressive; regulation is simpler to understand but blunt and costly to enforce; tradable permits achieve a fixed environmental target at least cost but require accurate cap-setting. For a positive externality or merit good, a subsidy lowers price but has a budgetary opportunity cost, while information provision is cheaper but slow to change behaviour. The best choice depends on the size and certainty of the externality, the elasticity of demand (an inelastic good responds little to a tax), the administrative capacity of government, and distributional concerns. Examiners reward answers that weigh these trade-offs and reach a justified recommendation rather than listing tools mechanically.