1.3 Methods of intervention: indirect taxes and subsidies, the incidence of tax and elasticity, maximum and minimum prices, tradable pollution permits, regulation, state provision and information provision.

What this dot point is asking

OCR wants you to explain the main methods of intervention (indirect taxes, subsidies, price controls, tradable permits, regulation, state provision and information provision), to draw their diagrams, to calculate the incidence of an indirect tax and link it to elasticity, and to evaluate each method.

Indirect taxes

On a diagram, the tax shifts the supply curve left (or up by the tax per unit). The price consumers pay rises, the price producers keep falls, and output falls. The government collects revenue equal to the tax per unit times the new quantity.

The incidence of a tax and elasticity

This is why taxes on inelastic demerit goods (tobacco, alcohol) raise a lot of revenue but cut consumption only modestly: consumers, not producers, bear most of the burden and keep buying.

Subsidies

Like a tax, the benefit of a subsidy splits between consumers (a lower price) and producers (a higher effective price received) according to elasticity. Subsidies risk government failure if they prop up inefficient producers or if the government misjudges the right amount.

Price controls

• Maximum price (price ceiling). A legal cap set below equilibrium to make a good more affordable (rent controls, energy price caps). It creates excess demand (a shortage) and can trigger black markets and falling quality.
• Minimum price (price floor). A legal floor set above equilibrium to support producers or discourage consumption (minimum alcohol pricing, agricultural support, the minimum wage in the labour market). It creates excess supply (a surplus), which the government may have to buy up.

A price control only "bites" if it is on the binding side of equilibrium: a ceiling above equilibrium or a floor below it has no effect.

Tradable pollution permits, regulation and information

• Tradable pollution permits. The government caps total emissions and issues permits that firms can trade. Firms that cut emissions cheaply sell spare permits; those that find it costly buy them. This prices the externality and achieves the target at least cost, as in the UK Emissions Trading Scheme.
• Regulation. Rules, standards, limits and bans (emission limits, age restrictions, compulsory seat belts). Certain and simple, but blunt and costly to enforce.
• State provision. The government provides public and merit goods directly (defence, the NHS, state schools), overcoming the free-rider problem and equity concerns.
• Information provision. Campaigns, labelling and education correct information failure (calorie labelling, anti-smoking campaigns), nudging consumption toward the optimum at relatively low cost.

Examples in context

• Sugar tax. The UK Soft Drinks Industry Levy (2018) is an ad valorem-style indirect tax that prompted reformulation, cutting the sugar in many drinks.
• Energy price cap. Ofgem's cap is a maximum price designed to protect consumers; critics warn it can distort the market and discourage supply.
• Minimum alcohol pricing. Scotland's floor price per unit (2018) is a minimum price aimed at the external costs of heavy drinking.

Try this

Q1. Explain why consumers bear most of an indirect tax when demand is price-inelastic. [4 marks]

• Cue. Inelastic demand means quantity barely falls when price rises, so producers can pass on most of the tax.

Q2. Explain why a maximum price set below equilibrium causes a shortage. [3 marks]

• Cue. At the lower capped price, quantity demanded exceeds quantity supplied, creating excess demand.