Cambridge International AS and A Level Economics: Microeconomic intervention (9708)

This guide covers section 3.2 (Methods and effects of government intervention in markets) of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topic 3 is AS Level content, and A Level candidates need it as assumed knowledge for Papers 3 and 4. It builds on demand, supply and market equilibrium and on the reasons for intervention in section 3.1. Every figure below is invented for illustration, in made-up markets.

Also use the revision notes, the practice questions, the course hub, the printable checklist and the free diagnostics.

What this unit covers

Section	You must be able to
3.2.1	Explain the impact and incidence of specific indirect taxes
3.2.2	Explain the impact and incidence of subsidies
3.2.3	Explain direct provision of goods and services
3.2.4	Analyse maximum and minimum prices
3.2.5	Analyse buffer stock schemes
3.2.6	Explain provision of information

For each method, ask what changes, who gains, who loses, and how well it fixes the problem. That is how evaluation is built.

3.2.1 Specific indirect taxes

A specific tax is a fixed amount per unit sold, collected from the seller. It raises the cost of supplying every unit, so the supply curve shifts vertically upwards by the amount of the tax. The market price rises by less than the tax and quantity falls.

Incidence means who actually bears the tax. The seller hands over the money, but the burden is shared between buyer and seller. The consumer’s share is the rise in the price paid. The producer’s share is the fall in the price kept after paying the tax.

Worked example 1 (candle market, invented). Demand is Qd = 200 − 10P and supply is Qs = −100 + 20P, with price in currency units (cu).

1. Equilibrium: 200 − 10P = −100 + 20P, so 30P = 300 and P = 10, Q = 100.
2. A tax of 3 cu: sellers need 3 more at every quantity, so supply becomes Qs = −100 + 20(P − 3). Setting equal to demand: 200 − 10P = −160 + 20P, so P = 12 and Q = 80.
3. Consumers pay 12, up 2. Producers keep 12 − 3 = 9, down 1.
4. Consumer burden = 2 × 80 = 160 cu. Producer burden = 1 × 80 = 80 cu. Tax revenue = 3 × 80 = 240 cu, which equals 160 + 80.
5. Lost trade: quantity falls by 20. The welfare loss is the triangle ½ × 3 × 20 = 30 cu of surplus that nobody receives.

Sketch of the diagram, described in words: the original supply curve S meets demand D at P = 10, Q = 100. The shifted curve S + tax sits 3 cu above S everywhere and meets D at P = 12, Q = 80. The gap between the new price and the new supply at Q = 80 is the tax.

Price paid by buyer      12 ---- consumer burden (2)
Original price           10
Price kept by seller      9 ---- producer burden (1)
Quantity                 80 (was 100)

Incidence and elasticity. The side that is less responsive to price bears more of the tax. If demand is inelastic, buyers cannot easily cut back, so they absorb most of it. Test it by making demand less elastic.

Worked example 2. Keep supply the same but let demand be Qd = 150 − 5P. At P = 10, Q = 100 and PED = −5 × 10 ÷ 100 = −0.5. Tax of 3 cu: 150 − 5P = −160 + 20P gives P = 12.4 and Q = 88.

• Consumers pay 2.4 more (burden 2.4 × 88 = 211.2 cu). Producers lose 0.6 per unit (0.6 × 88 = 52.8 cu).
• Revenue = 3 × 88 = 264 cu, higher than 240 cu, and quantity falls by only 12 rather than 20.

Compare with example 1, where PED at equilibrium was −1. Less elastic demand means a bigger consumer share, more revenue and a smaller fall in output.

Why governments use indirect taxes. Two main aims. First, to correct a negative externality: a tax equal to the marginal external cost makes the producer pay the full social cost. Second, to raise revenue.

Worked example 3. Suppose each unit of a charcoal grill (invented) causes 3 cu of smoke damage. Without a tax, 100 are sold. Counting the damage, the socially best quantity is 80, so the tax in example 1 moves the market there and removes the 30 cu welfare loss from over-consumption. In practice, the external cost is hard to measure, so the tax may be set too high or too low.

Evaluation points.

• Demand for demerit goods tends to be inelastic, so quantity may fall little. The tax mostly raises revenue.
• Poorer households spend a larger share of income on taxed goods, so the tax can be regressive.
• Sellers may avoid it through smuggling or illegal sales.
• Revenue can be used to fund other policies.

3.2.2 Subsidies

A subsidy is a payment to producers per unit. It lowers costs, so supply shifts downwards by the subsidy. Price falls by less than the subsidy, and quantity rises.

Worked example 4 (adult literacy classes, invented; same demand and supply as example 1 for easy comparison). A subsidy of 3 cu per class.

1. New supply: Qs = −100 + 20(P + 3). Setting equal to demand: 200 − 10P = −40 + 20P, so P = 8 and Q = 120.
2. Consumers pay 8, down 2. Producers receive 8 + 3 = 11, up 1.
3. Consumer gain = 2 × 120 = 240 cu. Producer gain = 1 × 120 = 120 cu. Cost to government = 3 × 120 = 360 cu, which equals 240 + 120.
4. If each class gives 3 cu of external benefit, the socially best quantity is 120, so the subsidy exactly corrects the under-consumption of a merit good.

Note the mirror image: incidence of a subsidy follows the same elasticity rule, with the benefit going mostly to the less elastic side.

Evaluation points.

• It has an opportunity cost: 360 cu could be spent elsewhere, funded by taxes.
• Producers may pocket the subsidy, or become inefficient and dependent on it.
• It is hard to set at the right level for the size of the benefit.
• It may encourage over-production if set too high.

3.2.3 Direct provision

The government produces and supplies the good or service itself, usually free at the point of use and funded by taxation. It is used where the market under-provides, as with public goods, or where access is considered a right.

Worked example 5 (a state clinic, invented). Running cost is 1,200,000 cu a year and it treats 30,000 patients.

• Cost per patient = 1,200,000 ÷ 30,000 = 40 cu.
• Opportunity cost: the same money could build other things. Whether it is worth it depends on benefit per patient compared with 40 cu.

At the margin, suppose each extra block of 1,000 check-ups costs 20,000 cu and gives these marginal social benefits: 50,000, 40,000, 30,000, 20,000, 10,000 cu. Provide blocks while benefit is at least cost. The fourth block breaks even and the fifth loses 10,000 cu. If the service is free, people use it until their own benefit falls to zero, which can exceed the efficient level.

Evaluation. Direct provision reaches everyone regardless of income and covers goods the market will not supply. But there may be waste, long queues, poor incentives to cut costs, and tax rises to pay for it. A mix of state and private supply is a common alternative.

3.2.4 Maximum and minimum prices

A maximum price is a legal ceiling. To matter, it must be set below the equilibrium. A minimum price is a legal floor. To matter, it must be set above the equilibrium.

Worked example 6 (rented rooms, invented). Demand is Qd = 600 − 40P and supply is Qs = 20P. Equilibrium: P = 10, Q = 200. The government sets a maximum rent of 6.

• Qd = 600 − 240 = 360 and Qs = 20 × 6 = 120. Shortage = 360 − 120 = 240.
• Only 120 rooms are rented (the short side of the market).
• At 120 rooms, tenants are willing to pay (600 − 120) ÷ 40 = 12, double the cap. This gap invites black markets and informal payments.

Effects: some tenants gain a lower rent, but the shortage means rationing by queue or favour, falling quality and fewer new rooms built. Over time supply is more elastic, so the shortage grows.

Worked example 7 (coconut market, invented). Demand is Qd = 400 − 20P and supply is Qs = −100 + 30P, giving P = 10 and Q = 200. A minimum price of 14.

• Qd = 400 − 280 = 120. Qs = −100 + 420 = 320. Surplus = 200.
• Consumer spending falls from 10 × 200 = 2,000 cu to 14 × 120 = 1,680 cu, since demand is elastic here.
• If the government buys the surplus: 14 × 200 = 2,800 cu extra spending. Farmers then sell 320 for 4,480 cu in total.

The intended gain is higher producer income, but the cost falls on taxpayers and consumers. Resources are over-allocated to coconuts, and storing the stock is costly. Minimum prices may also hold back farmers from shifting to other crops.

3.2.5 Buffer stock schemes

An agency tries to keep a price between a floor and a ceiling for a commodity whose supply varies with harvests. It buys when the price would fall below the floor and sells from stock when it would rise above the ceiling.

Worked example 8 (a grain market, invented). Demand is Qd = 1,000 − 2P. Harvests: poor 450, normal 600, good 750 (supply is fixed within a year).

• Free prices: poor harvest P = (1,000 − 450) ÷ 2 = 275. Normal 200. Good 125.
• The agency sets a floor of 175 and ceiling of 225.
• Good year: at 175, demand is 1,000 − 350 = 650, so the agency buys 750 − 650 = 100 at 175, costing 17,500 cu.
• Poor year: at 225, demand is 1,000 − 450 = 550, so the agency sells 550 − 450 = 100 at 225, earning 22,500 cu.
• Net gain over one good and one poor year: 22,500 − 17,500 = 5,000 cu, before storage costs.

Prices move within 175–225 rather than 125–275, which helps farmers plan and buyers budget.

Evaluation points.

• Storage costs and spoilage reduce the gain.
• Running out of stock after repeated poor harvests, or filling storage after repeated good ones, breaks the scheme.
• Setting the band around the wrong long run price builds up permanent surpluses or shortages.
• Farm income is still not fully stable because quantity changes.

3.2.6 Provision of information

Imperfect information leads to poor choices: people under-estimate the harm of demerit goods and the benefit of merit goods. Governments can provide labelling, advertising campaigns, warnings and education.

Worked example 9 (a sugar-warning campaign, invented). Annual consumption is 400,000 units. The campaign costs 90,000 cu and consumption falls to 340,000.

• Change = (340,000 − 400,000) ÷ 400,000 × 100 = −15%.
• Cost per unit of reduction = 90,000 ÷ 60,000 = 1.50 cu.
• If PED is −0.5, a price rise would have to be 15 ÷ 0.5 = 30% to get the same fall in quantity.

So information can reach the goal at a lower cost than a heavy tax when demand is inelastic.

Evaluation points. It is cheap, avoids price rises, and keeps choice. But effects are slow and uncertain, addictive habits may not respond, and people may ignore it or misunderstand it. Used alone it may fail; combined with tax or regulation it is stronger.

Common errors

• Drawing a tax as a shift of demand rather than supply.
• Forgetting that the producer’s share equals the price received after the tax, not the market price.
• Calling a price cap effective when it is set above equilibrium.
• Saying a maximum price causes a surplus.
• Giving only advantages: always weigh costs, elasticity, time and who gains.

Official syllabus

Cambridge International AS & A Level Economics (9708), syllabus for examination in 2026, 2027 and 2028, published by Cambridge International, topic 3, section 3.2.