AQA A-level Economics: Government intervention: tax, subsidy, price controls (7136) – Revision Notes

These notes condense the AQA AS and A-level Economics specification (version 1.3, 29 June 2022) sub-section Government intervention in markets: 3.1.5.8 on the AQA website, printed as 4.1.8.9 in the combined PDF. The specification gives no AS-only or A-level-only labels for it. Full explanations and different worked examples are in the study guide; test yourself with the practice questions. Course pages: AQA A-level Economics hub, printable checklist and the free diagnostics. All figures are invented.

The argument for intervention

• Market failure means resources are misallocated: price ignores some costs or benefits, or the market does not supply the good at all.
• Governments use public expenditure, taxation and regulation.
• Objectives conflict: efficiency, fairer incomes, growth, stable prices, a balanced budget, re-election. Name the objective when you judge a tool.
• A mixed economy keeps markets for most decisions and uses intervention where the market fails.
• Market strengths: prices signal scarcity, incentives reward effort, consumers choose. Weaknesses: market failure and unequal incomes. Judge each case by asking where the market does better than government, and where worse.

Tools at a glance

Tool	What it does	Main weakness
Specific tax	Fixed sum per unit; supply shifts up in parallel	External cost hard to measure
Ad valorem tax	Percentage of price; supply pivots	Same; tax per unit varies with price
Subsidy	Payment per unit; supply shifts down	Opportunity cost to taxpayers
Maximum price	Ceiling below equilibrium	Shortage, black market, falling quality
Minimum price	Floor above equilibrium	Surplus; buyers pay more
State provision	Government funds or runs supply	Cost, overuse if free, quality
Regulation	Rules, standards, bans	Enforcement cost; less flexible
Property rights	Give an owner a reason to protect	Hard to define and enforce
Pollution permits	Cap plus tradable permits	Cap setting, allocation, monitoring

Methods in steps

Tax or subsidy on a linear market

1. Find equilibrium: set Qd = Qs.
2. Tax t: replace P by (P − t) in supply. Subsidy s: replace P by (P + s).
3. Solve for the new price paid by buyers and the quantity.
4. Seller receives: price paid minus tax (or plus subsidy).
5. Buyer burden = rise in price paid × new quantity. Seller burden = fall in price received × new quantity.
6. Government revenue (or cost) = rate × new quantity.

Ad valorem tax of r: buyers pay (1 + r) × the price sellers receive, so write Qd using that price.

Price control

1. Find equilibrium.
2. Check the control binds (maximum below it, minimum above it).
3. Read Qd and Qs at the controlled price. The shorter side is what trades.
4. Shortage or surplus = the gap between Qd and Qs.

Worked reminders

Ad valorem tax. Qd = 360 − 20P and Qs = −60 + 10P. Equilibrium: 420 = 30P, so P = 14 and Q = 80. A 25% ad valorem tax: buyers pay 1.25Ps, so 360 − 25Ps = −60 + 10Ps. That gives 420 = 35Ps, so Ps = 12, buyers pay 15 and Q = 60. Tax per unit = 3 and revenue = 180. Buyers bear (15 − 14) × 60 = 60 and sellers bear (14 − 12) × 60 = 120. Total 180. Demand here is elastic (PED about 3.5 in size) and supply less so (PES 1.75), so sellers bear twice as much: the burden splits in the ratio PES : PED.

Inelastic versus elastic demand. Both markets start at P = 16 and Q = 140 with supply Qs = −20 + 10P, and each faces a tax of 6.

• Inelastic (Qd = 220 − 5P, PED 0.57): new price 20, Q = 120, revenue 720. Buyers bear two thirds.
• Elastic (Qd = 380 − 15P, PED 1.71): new price 18.4, Q = 104, revenue 624. Buyers bear two fifths.

Inelastic demand raises more revenue and cuts output less. It suits a revenue aim, not a behaviour aim.

Minimum price in a farm market. Qd = 500 − 10P and Qs = −100 + 20P. Equilibrium: P = 20 and Q = 300. A floor of 25: Qd = 250, Qs = 400, surplus 150. If the government buys the surplus it spends 150 × 25 = 3,750. Farmers then earn 400 × 25 = 10,000 against 6,000. Buyers pay more, taxpayers pay for the surplus, and over-production continues.

Permits and state provision in brief. Two firms must cut 20 tonnes together. X cuts at 6 per tonne and Y at 15. With each cutting 10 the cost is 210. With trading X cuts all 20 for 120, and Y buys the permits. Any permit price between 6 and 15 leaves both better off than the alternative. For provision, compare programmes by net benefit (benefit minus cost) and by benefit-cost ratio, and say which fits the budget.

Government objectives in action. A tax on a demerit good meets an efficiency aim, but if buyers have low incomes it conflicts with a fairness aim. A maximum rent meets fairness for existing tenants, but conflicts with efficiency if supply falls. A subsidy meets an output aim, but conflicts with a balanced budget. Show the conflict, then decide which objective carries more weight.

Chains of reasoning

• Tax. Tax raises costs, so supply shifts up, so the price paid rises and output falls. If the failure is an external cost, output moves towards the social optimum. The effect is larger when demand is elastic.
• Subsidy. Subsidy cuts costs, so supply shifts down, so price falls and output rises, towards the social optimum if there is an external benefit. It costs taxpayers and is only worthwhile if the benefit outweighs the cost.
• Maximum price. The ceiling holds price below equilibrium, so quantity demanded rises and quantity supplied falls. The shortage leads to rationing, queues or black markets, and supply may shrink further over time.
• Minimum price. The floor holds price above equilibrium, so quantity demanded falls and quantity supplied rises. The surplus must be bought, stored or left unsold.

Must-know distinctions

• Tax shifts supply up. Subsidy shifts supply down. Neither shifts demand.
• Price paid by buyers differs from price received by sellers; the gap is the tax or subsidy.
• Legal incidence (who must pay) is not economic incidence (who bears the burden). Elasticity decides the second.
• Maximum price causes shortage. Minimum price causes surplus.
• Regulation fixes the action. Permits fix the total and let trading find the cheapest cuts.
• Open access has no owner. Property rights give one.
• Opportunity cost of intervention (what the money could have done) is a cost even when the policy works.

Evaluation toolkit

For or against intervention in a particular market, weigh these:

• Size of the failure. Is the external cost or benefit large and measurable?
• Elasticities. Will the tool change behaviour, or only raise money or cause shortages?
• Winners and losers. Who pays, and is that fair? Is the effect regressive?
• Cost. Revenue, administration, opportunity cost.
• Unintended effects. Black markets, surpluses, avoidance.
• Time. Short-run versus long-run effects, such as supply falling under rent controls.
• Alternatives. Would regulation, permits or doing nothing perform better?

Quick self-test

1. Which curve shifts when an indirect tax is imposed, and in which direction?
2. A tax of 4 per unit raises the price buyers pay by 1. How much of the tax per unit falls on sellers?
3. A subsidy of 5 per unit is paid on 200 units. What does it cost?
4. Qd = 300 − 10P and Qs = −60 + 20P. A maximum price of 10 is set. What is the shortage?
5. A binding minimum price is set above equilibrium. Is the result a shortage or a surplus?
6. A specific tax of 8 is paid on 150 units. What is the revenue?
7. PED is −0.5. A tax raises price by 10%. What happens to quantity demanded?
8. Two firms must cut 20 tonnes in total. Cutting costs 6 per tonne for X and 15 for Y, and each would cut 10 without trading. By how much does trading lower the total cost of the cut?
9. Why does open access to a fishing ground lead to overuse?
10. Give one reason a maximum price may reduce housing quality over time.

Answers

1. Supply, upward (leftward), by the amount of the tax at each quantity.
2. 4 − 1 = 3.
3. 5 × 200 = 1,000.
4. Equilibrium is P = 12. At 10: Qd = 200 and Qs = 140. Shortage = 60.
5. A surplus: sellers want to supply more than buyers want to buy.
6. 8 × 150 = 1,200.
7. Quantity falls by about 5% (−0.5 × 10).
8. Without trading: 10 × 6 + 10 × 15 = 210. With X cutting all 20: 120. Saving = 90.
9. No one owns the stock, so each boat ignores the cost it puts on others, and boats keep joining until profit is zero.
10. Landlords earn a capped return, so they spend less on upkeep and may leave the market.

Where marks are usually lost

• Moving the demand curve when a tax or subsidy changes costs.
• Drawing the tax gap between curves as the whole price rise.
• Forgetting that a maximum price only matters if it is below equilibrium.
• Assuming the buyer always bears the whole tax.
• Describing a tool without saying which failure it targets.
• Stating weaknesses in a list with no link to the market in the question.
• Leaving out a judgement, or giving one with no reason.
• Treating a subsidy’s cost as a social loss without weighing the benefit.

Official syllabus

AQA AS and A-level Economics, specification version 1.3 (29 June 2022), AQA. Sub-section covered: Government intervention in markets (3.1.5.8 on the AQA website; 4.1.8.9 in the combined PDF).