1.4.1 Government Intervention in Markets

What is government intervention?

When the government steps into markets to influence prices, quantities, or behaviour to correct market failure.

Why does the government intervene in markets?

To fix market failure caused by externalities, information gaps, public goods, market power, and merit/demerit goods.

What is an indirect tax?

A tax on spending (e.g. VAT, excise duties) used to reduce harmful consumption, internalise negative externalities, and raise revenue.

Difference between specific and ad valorem tax?

• Specific: Fixed amount per unit; shifts supply up in parallel.

• Ad valorem: % of price; supply gets steeper as price rises.

Advantages and disadvantages of indirect taxes?

Raise revenue
Reduce harmCan cause black markets
ful consumption

Regressive

What is a subsidy?

Government payment to producers to lower costs and encourage consumption of merit goods or positive externalities.

What happens when a subsidy is given?

Supply shifts right/down → lower price → higher quantity → more consumption.

Advantages and disadvantages of subsidies?

Encourages beneficial consumption

Over‑consumption

High opportunity cost
Increases positive externalitys

What is a maximum price?

A legal price set below equilibrium to protect consumers. Causes shortages and possible black markets.

What are public goods?

Non‑excludable and non‑rival goods (e.g. defence, street lighting). Government provides them due to the free‑rider problem.

Why does the government provide information?

To reduce information failure and help consumers make rational decisions (e.g. labels, health warnings).

What is regulation?

Government rules to control market behaviour (e.g. minimum wage, safety standards, environmental rules).