Cambridge A Level Economics: Market-failure policies: taxes, subsidies, controls and quotas (9708) – Revision Notes

These notes condense the first part of section 8.1.1 of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topics 7 to 11 are A Level content, so this unit is not examined at AS. For full explanations, read the study guide, then test yourself with the practice questions. The course hub, the printable checklist and the free diagnostics show where this unit sits. All figures here are invented.

The measures at a glance

Measure	Effect on the market	Best used for	Main weakness
Specific tax	Supply shifts up by the tax	Negative externalities	Hard to set; may be regressive
Ad valorem tax	Supply pivots; tax per unit rises with price	Revenue and demerit goods	Same, and revenue varies with price
Subsidy	Supply shifts down	Merit goods, positive externalities	Cost to taxpayers
Maximum price	Shortage below equilibrium	Access to essentials	Black markets, lower quality
Minimum price	Surplus above equilibrium	Demerit goods, producer income	Extra spending goes to sellers
Quota	Vertical supply at the cap	Limited stocks	Allocation, cheating
Prohibition	Legal supply removed	Dangerous products	Black market
Licence	Limits who may supply	Standards, numbers	Restricts entry
Regulation	Rules on price, quality, entry	Monopoly power	Regulator lacks information
Direct provision	State supplies	Public and merit goods	Cost, waste, tax funding

Formulas and rules

Item	Rule
Consumer burden of a tax	(new price paid − old price) × new quantity
Producer burden of a tax	(old price − price kept after tax) × new quantity
Tax revenue	tax per unit × new quantity
Welfare loss from a tax	½ × tax per unit × fall in quantity
Subsidy cost	subsidy per unit × new quantity
Burden shares	The less elastic side bears more
Price elasticity of demand (point)	(change in Qd per 1 cu rise in P, a negative number) × P ÷ Q
Quota rent per unit	price paid − supply price at the quota
Benefit-cost ratio	total benefit ÷ total cost

Taxes: method in steps

1. Find the no-tax equilibrium by setting Qd = Qs.
2. For a specific tax t, replace P with (P − t) in supply and solve.
3. For an ad valorem rate r on the seller’s price Ps, replace P with (1 + r)Ps in demand and solve for Ps.
4. State price paid, price kept, quantity.
5. Work out the burdens, revenue and welfare loss, and check they add up.

Worked reminder (a fictional market for garden sheds). Qd = 360 − 6P and Qs = −60 + 4P. No tax: P = 42 and Q = 108. A specific tax of 10 cu gives −60 + 4(P − 10) = 360 − 6P, so P = 46 and Q = 84. Sellers keep 36.

• Consumer burden = 4 × 84 = 336 cu. Producer burden = 6 × 84 = 504 cu. Revenue = 840 cu, which equals 336 + 504.
• Welfare loss = ½ × 10 × (108 − 84) = 120 cu.
• Elasticities at equilibrium: PED = −6 × 42 ÷ 108 = −2.33 and PES = 4 × 42 ÷ 108 = 1.56. Demand is more elastic, so producers bear the larger share.

Ad valorem check. A 10% tax on a seller price of 50 cu is 5 cu per unit. At 80 cu it is 8 cu. A specific tax of 5 cu stays at 5 cu.

Subsidies: method and reminder

Replace P with (P + s) in supply. The consumer gain is (old price − new price) × new quantity. The producer gain is (price received − old price) × new quantity. These add to the subsidy cost.

Worked reminder (same shed market, subsidy of 5 cu). Qs = −60 + 4(P + 5) = −40 + 4P. Setting equal to demand: 360 − 6P = −40 + 4P, so P = 40 and Q = 120. Sellers receive 45.

• Consumer gain = 2 × 120 = 240 cu. Producer gain = 3 × 120 = 360 cu. Cost = 5 × 120 = 600 cu.

Evaluation chain. The subsidy lowers cost, so output rises. If the external benefit equals the subsidy, output reaches the social optimum. But the cost is tax-funded, the benefit is hard to measure, and the more elastic supply is, the more of the benefit reaches consumers.

Price controls

• A maximum price only bites below equilibrium. A minimum price only bites above it.
• The short side of the market decides quantity traded.
• A maximum price: shortage = Qd − Qs at the cap. Black-market price = price on the demand curve at the quantity actually supplied.

Worked reminder (a fictional market for repair appointments). Qd = 500 − 5P and Qs = −100 + 15P. Equilibrium: P = 30 and Q = 350. A maximum of 24 cu gives Qd = 380 and Qs = 260, so the shortage is 120. Buyers would pay (500 − 260) ÷ 5 = 48 cu for the last unit supplied.

Minimum price chain. Price floor above equilibrium, so quantity demanded falls and supply exceeds demand. Consumption falls by less than the price rise if demand is inelastic. Sellers gain revenue per unit. The state gains nothing unless it buys the surplus.

Quotas, prohibitions and licences

• A quota fixes output. Price rises to clear demand at the quota.
• Quota rent is the gap between the price and the supply price at the quota. It goes to quota holders.
• An equivalent specific tax gives the same price and output, but the revenue goes to the state.
• A prohibition removes the legal market. Evaluate demand elasticity, enforcement cost and black-market risks.
• A licence limits entry and can raise standards. The fee is revenue; the cap restricts competition.

Regulation and deregulation

Regulation uses price caps, quality standards and entry rules. In a natural monopoly:

1. Unregulated: set MR = MC to find Q, then read P from demand.
2. Cap at AC: solve demand price = AC. Profit is normal and output rises.
3. Cap at MC: output is highest, but the firm makes a loss equal to fixed cost and needs a subsidy.

Worked reminder (a fictional gas network). Demand is P = 100 − Q, MC = 10 cu and fixed cost = 800 cu.

• Unregulated: 100 − 2Q = 10, so Q = 45 and P = 55. Cost = 10 × 45 + 800 = 1,250 cu and revenue = 2,475 cu, so profit = 1,225 cu.
• Cap at AC: 100 − Q = 10 + 800 ÷ Q gives Q² − 90Q + 800 = 0, so Q = 80 (or 10), P = 20 and AC = 20.
• Cap at MC: P = 10 and Q = 90, with a loss of 800 cu.

Deregulation removes controls to increase competition. Gains: lower prices, more choice, lower costs. Risks: lower quality or safety, cuts to unprofitable services, and the loss of a regulator’s oversight.

Direct provision

Public goods are non-excludable and non-rival, so private firms cannot profit. The state supplies them and funds them from tax. Check with a benefit-cost ratio above 1. Free provision of a merit good can cause over-use and queues.

Must-know distinctions

• Specific tax: parallel shift. Ad valorem tax: pivot.
• Quota: state or agency controls output. Tax: state changes price and output follows.
• Maximum price: shortage. Minimum price: surplus.
• Regulation: rules for an existing market. Deregulation: fewer rules or barriers.
• Prohibition: total ban. Licence: permitted but limited.

Quick self-test

1. A shed market has Qd = 360 − 6P and Qs = −60 + 4P. State the equilibrium price.
2. Calculate the price buyers pay after a specific tax of 10 cu.
3. A 20% ad valorem tax is added to a seller price of 30 cu. What is the tax per unit and what do buyers pay?
4. A subsidy of 5 cu is paid in the same market. Calculate its cost.
5. A maximum price of 24 cu is set where Qd = 500 − 5P and Qs = −100 + 15P. Calculate the shortage.
6. State why a maximum price above equilibrium has no effect.
7. A quota holds output at 400 when buyers pay 50 and the supply price is 38. Calculate the quota rent.
8. State one difference between a quota and an equivalent tax.
9. A project costs 90,000 cu and gives benefits of 117,000 cu. Calculate the benefit-cost ratio.
10. Give one reason why deregulation may reduce quality.

Answers

1. P = 42 cu (Q = 108).
2. 46 cu (quantity 84).
3. Tax per unit = 0.2 × 30 = 6 cu. Buyers pay 36 cu.
4. 5 × 120 = 600 cu.
5. Qd = 380 and Qs = 260, so the shortage is 120.
6. The market already clears at a lower price, so the cap is not binding.
7. (50 − 38) × 400 = 4,800 cu.
8. The quota’s rent goes to quota holders, while the tax’s revenue goes to the government.
9. 117,000 ÷ 90,000 = 1.3.
10. Firms facing more competition may cut costs by reducing safety or service standards.

Where marks are usually lost

• Drawing a tax or subsidy as a movement of the demand curve.
• Using the market price as the producer’s share of a tax.
• Putting a price control on the wrong side of equilibrium and still drawing a shortage or surplus.
• Writing a price rise without saying how quantity responds.
• Forgetting that a quota’s extra income goes to the sellers.
• Giving a one-sided answer when the question says evaluate.
• Leaving out units or labels on a numerical answer.
• Mixing up the price a buyer pays with the price a seller keeps.

Official syllabus

Cambridge International AS & A Level Economics (9708), syllabus for examination in 2026, 2027 and 2028, published by Cambridge International, section 8.1.1.