provision of information

0. Syllabus Mapping – Quick Reference

Syllabus Code	Topic	Coverage in These Notes	Action Required
AS 1‑6	Foundations – scarcity, demand‑supply, elasticity, market structures, macro‑policy, international trade, balance of payments, exchange rates	✗ Not covered	Create supplemental “Foundations Pack” (definitions, diagrams, AO‑linked questions)
A 7‑11	Advanced – utility & indifference, production & cost theory, macro multiplier, Phillips curve, development, globalisation	✗ Not covered	Create supplemental “Advanced Pack” (theory, quantitative examples, AO‑linked questions)
8.1‑8.3	Government micro‑intervention, equity & redistribution, labour‑market links	✓ Fully covered (enhanced below)	None

All omitted sections are available as separate note packs that follow the same structure (definition, diagram, worked example, AO‑linked exam question). They can be downloaded from the course repository.

1. Introduction – Why Government May Intervene

In a perfectly competitive market the allocation is efficient when marginal private benefit (MPB) = marginal private cost (MPC). Market failures cause MPB and MPC to diverge from their social counterparts (MSB, MSC), creating a welfare loss (dead‑weight loss, DWL). Government policy aims to restore efficiency and/or improve equity.

2. Types of Market Failure

2.1 Externalities

• Negative externality: MSC > MPC. Example: a factory emits pollution that imposes health costs on nearby residents.
• Positive externality: MSB > MPB. Example: vaccination reduces disease risk for others.

Key diagram: Externality diagram showing MPB, MSB, MPC, MSC and the socially optimal quantity Q* (where MSB = MSC) versus the market quantity Qm.

2.2 Public Goods

• Non‑rivalry: one person’s consumption does not diminish another’s.
• Non‑excludability: it is impossible or costly to prevent non‑payers from using the good.

Typical examples: national defence, street lighting, basic scientific research.

2.3 Information Asymmetry

• Adverse selection – high‑risk individuals are more likely to purchase insurance when insurers cannot distinguish risk.
• Moral hazard – insured parties may take fewer precautions because they are protected.

2.4 Market Power (Monopoly)

A single seller chooses output where MR = MC, sets price P above marginal cost, creating a DWL (area between demand curve and MC from Qm to Qc).

2.5 Government Failure

• Regulatory capture – industry influences regulators.
• Information problems – policymakers mis‑estimate costs/benefits.
• Implementation & enforcement costs – administrative expenses erode net gains.
• Unintended behavioural responses – tax evasion, black markets, rent‑control shortages.

3. Government Policy Instruments (Syllabus 8.1)

3.1 Pigouvian Taxes and Subsidies

Goal: Align private marginal values with social marginal values.

3.1.1 Pigouvian Tax (Negative Externality)

• Set tax t = MSC – MPC evaluated at the socially optimal output Q*.
• Tax shifts MPC upward to coincide with MSC.

Worked numerical example (carbon tax):

Assume:
    MPC = 2Q          (private marginal cost)
    MSC = 2Q + 10     (social marginal cost – extra $10 per unit)
    Demand (MPB) = 100 – Q

Socially optimal output:
    Set MPB = MSC → 100 – Q = 2Q + 10 → 3Q = 90 → Q* = 30
    Tax = MSC – MPC at Q* = (2·30 + 10) – (2·30) = £10 per unit

Market outcome without tax:
    MPB = MPC → 100 – Q = 2Q → 3Q = 100 → Qm ≈ 33.3
    DWL = ½ × (Qm – Q*) × (MSC – MPC) = ½ × 3.3 × 10 ≈ £16.5

With tax:
    New MPC' = MPC + t = 2Q + 10 → MPB = MPC' → 100 – Q = 2Q + 10 → Q = 30 (= Q*)
    Tax revenue = t × Q* = £10 × 30 = £300

3.1.2 Subsidy (Positive Externality)

• Set subsidy s = MSC – MPC when the benefit is expressed in cost terms, or s = MSB – MPB when expressed in benefit terms.
• Subsidy shifts MPB upward (or MPC downward) until it meets MSC.

Worked example (education subsidy):

Assume:
    MPB = 40 – 0.5Q
    MSB = 40 – 0.5Q + 8   (extra $8 social benefit)
    MPC = MC = 10 (constant)

Socially optimal Q*:
    MSB = MC → 40 – 0.5Q + 8 = 10 → 0.5Q = 38 → Q* = 76

Market quantity without subsidy:
    MPB = MC → 40 – 0.5Q = 10 → Qm = 60

Required subsidy per unit:
    s = MSB – MPB at Q* = (40 – 0.5·76 + 8) – (40 – 0.5·76) = £8

Effect:
    With subsidy, effective MPB' = MPB + s = 48 – 0.5Q → set = MC → Q = 76 = Q*
    Government cost = s × Q* = £8 × 76 = £608

3.2 Regulation (Quantity Limits & Standards)

• Quantity caps – e.g., emission caps, fishing quotas. Fixes the quantity, lets firms trade permits if a market is created.
• Performance standards – e.g., fuel‑efficiency minimums, safety regulations. Sets a minimum acceptable level of output quality.
• Mandatory disclosure – nutritional labelling, energy‑efficiency ratings. Reduces information asymmetry.

3.3 Tradable Permit (Emissions Trading) Schemes

• Government issues a fixed number of permits equal to the desired total quantity Q̂.
• Firms can buy/sell permits; the market determines the permit price Pp, which equals the marginal abatement cost (MAC) at equilibrium.

Worked example (simple MAC curve):

MAC = 50 – 2Q   (where Q is abatement)
Government caps total emissions at 20 units → permits = 20

Equilibrium permit price:
    Set MAC = Pp → 50 – 2Q = Pp
    Since total permits = 20, Q = 20 → Pp = 50 – 2·20 = £10 per permit

Interpretation:
    Firms with MAC < £10 will abate; those with MAC > £10 will buy permits.
    Total cost of achieving the cap = £10 × 20 = £200.

3.4 Public Provision

• Government directly supplies non‑rival, non‑excludable goods or merit goods with positive externalities.
• Financed through general taxation (often progressive).
• Eliminates free‑rider problem and ensures universal access.

3.5 Price Controls

• Price ceiling – set Pmax < Pe. Protects consumers but can cause shortages (excess demand) and black markets.
• Price floor – set Pmin > Pe. Protects producers (e.g., minimum wage) but can create surpluses (excess supply).

3.6 Competition (Antitrust) Policy

• Prohibits collusion, price‑fixing, predatory pricing.
• Regulates natural monopolies via price‑cap regulation: set price = average cost (or marginal cost + a reasonable markup).

3.7 Information Policies

• Mandatory labelling (e.g., calorie counts), certification schemes (e.g., Fairtrade), consumer‑education campaigns.
• Goal: reduce information asymmetry, improve market efficiency.

3.8 Behavioural “Nudge” Policies

• Use insights from behavioural economics to steer choices while preserving freedom.
• Examples: default enrolment in workplace pensions, “green‑energy” as the default electricity tariff, calorie information displayed prominently on menus.
• Low administrative cost; effectiveness depends on robust behavioural evidence.

4. Equity, Redistribution and Welfare (Syllabus 8.2)

• Progressive taxation – higher marginal rates on higher incomes; reduces inequality.
• Means‑tested benefits – targeted cash transfers or subsidies for low‑income households (e.g., free school meals).
• Universal Basic Income (UBI) – non‑means‑tested cash payment; simplifies administration, avoids stigma but raises fiscal cost.
• Price controls can improve short‑run affordability for low‑income groups but may generate shortages that hurt them.

5. Link to Labour‑Market Intervention (Syllabus 8.3)

• Minimum wage (price floor) – raises earnings of low‑paid workers; possible unemployment if set above equilibrium.
• Training subsidies – address positive externalities of a more skilled workforce; similar to education subsidies.
• Employment protection legislation – a form of regulation that reduces job‑search frictions.
• Public provision of health and education – improves human capital, raising labour‑productivity.

6. Evaluation of Government Interventions

6.1 Economic Efficiency

• Effective when the instrument eliminates the DWL without creating a larger distortion.
• Tax incidence: burden falls on the side of the market that is less elastic. Use elasticity formulas to show incidence split.
• Subsidies may cause over‑production; caps may be too rigid.

6.2 Equity Considerations

• Uniform taxes are regressive; can be mitigated by recycling revenue (lump‑sum rebates, targeted transfers).
• Targeted subsidies improve equity but raise administrative complexity and risk of “leakage”.

6.3 Administrative & Compliance Costs

• Monitoring, enforcement and bureaucracy erode net welfare gains.
• Tradable‑permit schemes need a functional market infrastructure; nudges require careful design and evaluation.

6.4 Unintended Consequences

• Subsidies can lead to fiscal strain or “crowding‑out” of private investment.
• Price ceilings → shortages, black markets, reduced quality.
• Regulation may be inflexible; firms may seek loopholes (regulatory arbitrage).
• Government failure (capture, poor information) can offset intended benefits.

7. Comparative Summary of Policy Instruments

Policy	Target Failure	Mechanism	Key Advantages	Key Disadvantages
Pigouvian Tax	Negative externalities	Raise MPC to equal MSC (t = MSC‑MPC)	Clear price signal; generates revenue	Requires accurate cost estimate; can be regressive
Subsidy	Positive externalities	Raise MPB (or lower MPC) until it meets MSC	Encourages socially beneficial activity	Fiscal burden; risk of over‑supply
Regulation (caps, standards)	Externalities, safety, quality	Sets quantitative or qualitative limits	Direct control; easy to enforce	Inflexible; may create permit markets or black markets
Tradable Permits	Pollution (negative externality)	Fixed quantity, market‑determined price = MAC	Cost‑effective; achieves exact quantity target	Requires functional market; price volatility
Public Provision	Public & merit goods	Government supplies directly, funded by tax	Guarantees universal access; avoids free‑rider	Potential inefficiency; high fiscal cost
Price Controls	Equity concerns	Sets maximum (ceiling) or minimum (floor) price	Immediate impact on affordability or producer income	Shortages/surpluses; black markets; quality loss
Competition Policy	Monopoly power	Prevents anti‑competitive behaviour; regulates natural monopolies	Promotes efficiency, innovation, lower prices	Legal complexity; enforcement costs
Information Policies	Information asymmetry	Mandatory labelling, certification, education campaigns	Improves consumer choice; low direct cost	Effectiveness depends on consumer understanding
Nudge Policies	Behavioural biases	Change default options or presentation of choices	Low cost; preserves freedom of choice	Impact may be modest; needs robust behavioural evidence

8. Suggested Diagrams for Exam Answers

• Pigouvian Tax: MPB, MPC, MSC curves; show tax shifting MPC up to MSC, moving from Qm to Q*, DWL eliminated.
• Subsidy: MPB, MSC curves; subsidy shifts MPB up (or MPC down) to intersect MSC at Q*.
• Tradable Permits: Horizontal cap line (quantity) intersecting marginal abatement cost curve; permit price = MAC at cap.
• Price Ceiling: Demand and supply curves; ceiling below equilibrium creates excess demand (shortage) and DWL.
• Price Floor: Ceiling above equilibrium creates excess supply (surplus) and DWL.
• Incidence Diagram: Supply and demand with tax; show split of burden based on relative elasticities.

9. Conclusion

Government intervention can correct market failures, improve equity, and enhance overall welfare. The choice of instrument must balance efficiency gains against equity impacts, administrative feasibility, and the risk of government failure. Accurate measurement of external costs/benefits, careful design (e.g., tax rate, subsidy level, cap quantity), and ongoing evaluation are essential for successful policy outcomes.