Topic 3: Government Intervention

 3.1 Reasons for Government Intervention

• Market failures occur when the price mechanism doesn’t allocate resources efficiently.
• Common reasons:
• Public goods (not provided by the market).
• Merit goods (under-consumed).
• Demerit goods (over-consumed).
• Externalities (spillover effects).
• Monopoly power (firms exploit consumers).
• Income inequality.

Memory cue: Think 'P-M-D-E-M-I' → Public, Merit, Demerit, Externalities, Monopoly, Inequality.

 

3.2 Types of Intervention

• Indirect taxes: raise price → reduce consumption (esp. demerit goods).
• Subsidies: lower price → encourage consumption/production (esp. merit goods).
• Price controls:
• Maximum price (price ceiling) → prevents exploitation, may cause shortages.
• Minimum price (price floor) → ensures fair income, may cause surpluses.
• Regulation: laws to control behaviour (pollution limits).
• Provision of goods/services: the government directly provides healthcare, education, and defence.

 

3.3 Externalities

• Positive externality: benefit to third parties (vaccination).
• Negative externality: cost to third parties (pollution).
• Market fails because external costs/benefits are not reflected in prices.
• Government can correct via taxes, subsidies, and regulation.

 

3.4 Advantages and Disadvantages of Intervention

• Advantages: corrects market failure, improves welfare, reduces inequality.
• Disadvantages: government failure (wrong policies, inefficiency), distortion of markets, and high costs.

 

3.5 Case Studies (common exam focus)

• Smoking → negative externality, taxed + regulated.
• Education → positive externality, subsidized + provided.
• Pollution → regulated + taxed.