EnglandEconomicsSyllabus dot point

What tools can governments use to correct market failure, and when does intervention make things worse?

Government intervention and government failure: indirect taxes and subsidies, maximum and minimum prices, regulation, tradable pollution permits and state provision, and the causes of government failure.

An Eduqas A520 answer to the policy toolkit for correcting market failure, covering indirect taxes and subsidies, maximum and minimum prices, regulation, tradable pollution permits, state provision and information provision, and the causes of government failure such as unintended consequences, information gaps and regulatory capture.

Generated by Claude Opus 4.813 min answerUpdated 2026-06-02

Reviewed by: AI editorial process; not yet individually human-reviewed

Have a quick question? Jump to the Q&A page

Quick answer

Governments correct market failure with a toolkit. Indirect taxes (specific or ad valorem) raise the private cost of a demerit good or negative externality toward the social cost, internalising it; their incidence depends on elasticity. Subsidies lower the price of a merit good or positive externality to raise consumption. Maximum prices (below equilibrium) protect consumers but cause shortages; minimum prices (above equilibrium) protect producers but cause surpluses. Regulation sets legal rules and standards; tradable pollution permits cap total emissions and let firms trade, so abatement happens where it is cheapest. The state also directly provides public and merit goods and provides information to correct information failure. But intervention can cause government failure, when it creates a net welfare loss through unintended consequences, distorted incentives, information gaps, administrative cost, regulatory capture or political short-termism.

Jump to a section

What this dot point is asking
Indirect taxes
Subsidies, price controls and regulation
Tradable permits and provision
Government failure
Examples in context
Try this

What this dot point is asking

Eduqas wants you to explain the main tools governments use to correct market failure (indirect taxes, subsidies, price controls, regulation, tradable permits, state and information provision), analyse their effects with diagrams, and evaluate them, including the ways in which intervention can itself fail. This is where the theory of market failure becomes policy, and it is heavily examined in both data response and essays.

Indirect taxes

The incidence (burden) of an indirect tax is split between consumers and producers according to elasticity: the more inelastic the demand, the more the burden falls on consumers; the more elastic, the more producers absorb. This is why taxes on inelastic demerit goods (tobacco) fall mainly on consumers and raise large revenues.

Subsidies, price controls and regulation

Tradable permits and provision

Government failure

The risk of government failure is the key evaluation point in any essay on intervention: a policy is only worthwhile if it corrects the market failure by more than the new distortions it creates.

Setting a Pigouvian tax to correct an externality

Step 1: state the externality

A good is produced in a free market at 1,000 units. Each unit imposes a marginal external cost of $\pounds 4$ on third parties, so $MSC = MPC + 4$ . The social optimum (where $MSC = MSB$ ) is 850 units.

Step 2: choose the tax

To internalise the externality, set a specific tax equal to the marginal external cost, $\pounds 4$ per unit. This shifts the supply curve (MPC) up by $\pounds 4$ so that it coincides with the marginal social cost curve.

Step 3: trace the effect

With the higher cost, the new market equilibrium output falls from 1,000 toward the social optimum of 850 units, and the price rises. Producers and consumers now face the full social cost of the good.

Step 4: evaluate

In theory the tax removes the deadweight welfare loss. In practice the external cost is hard to measure, so the tax may be set too high or low (an information gap), and the tax is regressive and may push activity abroad, illustrating the risk of government failure even from a well-designed tax.

Examples in context

Sugar levy. The UK soft-drinks industry levy is an indirect tax on a demerit good that also reformulated products, a partial policy success.
Rent controls. Price ceilings that have reduced the supply and quality of rental housing where tried, a textbook government failure.
Emissions trading. The EU and UK Emissions Trading Schemes cap carbon and let firms trade permits, putting a market price on pollution.

Try this

Q1. Explain why a maximum price set below the equilibrium price causes a shortage. [4 marks]

Cue. At the lower legal price, quantity demanded exceeds quantity supplied; the price cannot rise to clear the market, so excess demand (a shortage) persists.

Q2. Explain one cause of government failure when subsidising a good. [4 marks]

Cue. Distorted incentives or information gaps: a subsidy may prop up inefficient producers, be hard to set at the right level, and cost more than the market failure it corrects.

Exam-style practice questions

Practice questions written in the style of WJEC Eduqas exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Eduqas Component 2 20206 marksThe government places a specific indirect tax of

\pounds 2

per unit on a good. With the help of a diagram, analyse how the burden of the tax is shared between consumers and producers when demand is price-inelastic.

Show worked answer →

A 6-mark analyse question. Knowledge and application: a specific tax shifts the supply curve vertically upward by the amount of the tax ( $\pounds 2$ ). Draw the supply shift and show the new, higher equilibrium price and lower quantity.

Analysis: the incidence of the tax depends on elasticity. With inelastic demand, consumers bear most of the burden because they cut quantity little when the price rises, so the price they pay rises by close to the full $\pounds 2$ , while producers absorb only a small share. Show the consumer and producer portions of the tax on the diagram (the rectangle split at the original price).

Markers reward an accurate tax-shift diagram, the correct split of incidence toward consumers, and the link to demand elasticity.

Eduqas Component 3 (micro) 202112 marksEvaluate the effectiveness of indirect taxes compared with tradable pollution permits in reducing carbon emissions.

Show worked answer →

A levels-of-response essay. Knowledge and application: explain a carbon tax (a Pigouvian tax that raises the private cost to the social cost, internalising the externality) and a tradable permit scheme (a cap on total emissions, with permits traded so abatement happens where it is cheapest). Use diagrams.

Analysis: develop how each cuts emissions, the tax by raising price, permits by fixing quantity.

Evaluation: compare certainty (permits fix the quantity of emissions but leave the price uncertain; a tax fixes the price but leaves the quantity uncertain), administrative cost, the difficulty of setting the right tax or cap, the risk of firms relocating (carbon leakage), distributional effects, and government failure. Conclude with a supported judgement, noting the trade-off between price and quantity certainty.

Related dot points

Sources & how we know this

Eduqas A Level Economics Specification (A520) — Eduqas (2015)