OCR A Level Economics: Government intervention, CBA and government failure (H460)

This guide follows the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It covers two topics in Component 1 (Microeconomics) under the area of study “Market failure and government intervention”: “Alternative methods of government intervention” and “Government failure”. All figures are invented; the countries are fictional.

Links: revision notes, practice questions, OCR economics hub, printable checklist, free 10-minute diagnostics. For the market failures themselves, see information failure, merit and demerit goods, public goods and inequity.

What you must be able to do

Specification statement	Section
Why governments intervene	1
How intervention corrects market failure and inequity, with diagrams: taxes and subsidies, state provision, buffer stocks, price controls, public/private partnerships, legislation and regulation, tradable permits, information provision, competition policy	2 to 5
Evaluate effectiveness	6
Cost Benefit Analysis: meaning, infrastructure use, value in decisions	7
Government failure: meaning, causes, consequences	8

1. Why governments intervene

• Market failure. Private decisions ignore external costs and benefits, so negative-externality goods are over-produced and positive ones under-produced. Public goods go unsupplied, information may be missing, and firms with market power restrict output.
• Inequity. Markets reward ownership of resources, so income, wealth and access to essentials such as healthcare can be very unequal.

2. Taxation and subsidies

Indirect tax. A specific tax is a fixed sum per unit and shifts supply vertically upwards by that sum. The price rises by less than the tax, so the burden is shared.

Worked example (tax on a good with an external cost). In Country A the market for disposable packaging has demand Qd = 240 - 6P and supply Qs = 4P - 40 (P in currency units, cu). Each unit imposes an external cost of 5 cu.

• Equilibrium: 240 - 6P = 4P - 40, so P = 28 cu and Q = 72.
• Marginal social cost is supply shifted up by 5 cu; setting it equal to demand gives the optimum, 60 units.
• A tax of 5 cu makes Qs = 4(P - 5) - 40. Then 240 - 6P = 4P - 60, so P = 30 cu and Q = 60: the optimum.
• Incidence: consumers pay 2 cu more, so bear 2/5 = 40%; producers receive 25 cu, 3 cu less, so bear 60%.
• Revenue: 5 x 60 = 300 cu. Deadweight loss removed: 0.5 x 5 x 12 = 30 cu.

Producers bear more because supply is less elastic here.

Subsidy. A subsidy shifts supply down (right) by the amount per unit. In Country A the market for adult training places has demand Qd = 100 - 2P and supply Qs = 3P - 20, so P = 24 cu and Q = 52. Each place has an external benefit of 5 cu.

• A subsidy of 5 cu gives Qs = 3(P + 5) - 20 = 3P - 5. Then 100 - 2P = 3P - 5, so P = 21 cu and Q = 58. Marginal social benefit is demand plus 5 cu: 110 - 2P = 3P - 20 also gives Q = 58, the optimum.
• Students pay 3 cu less (60%); providers receive 26 cu, 2 cu more. Cost: 5 x 58 = 290 cu. Welfare gain: 0.5 x 5 x 6 = 15 cu.

The gain (15 cu) is small next to the cost (290 cu): most of the subsidy pays for places bought anyway.

3. Government expenditure, state provision and public/private partnerships

State provision. The government pays for a good or service and usually supplies it free or below cost, funded from taxation. It suits public goods, which the market will not supply, and merit goods such as education and healthcare, where access should not depend on income. Transfer payments to low-income households tackle inequity directly. Diagram: supply becomes a vertical line at the quantity provided, with the price paid at zero; compare that quantity with the social optimum. Weaknesses: opportunity cost of tax revenue, weaker cost discipline, and difficulty judging how much to provide.

Public/private partnerships (PPPs). A private firm builds, finances and perhaps operates an asset (a hospital, a school, a road) and the government pays for its use over many years. The aim is to use private expertise and finance and pass risk, such as cost overruns, to the firm; show the extra output on the externality diagram. Drawbacks: the partner needs a profit, so payments can exceed the cost of public borrowing; contracts are complex; the government may keep the real risk.

4. Buffer stock systems and price controls

Buffer stocks stabilise the price of storable goods, typically farm products. The agency buys when the price would fall below a floor price and sells when it would rise above a ceiling price.

Worked example. In Country B demand for grain is Qd = 400 - 4P. The price band is 40 to 60 cu per tonne.

• Bumper harvest, Qs = 12P - 112: the free price is 32 cu (Q = 272), below the floor.
• At 40 cu, demand is 240 and supply 368, so the agency buys 128 tonnes at a cost of 128 x 40 = 5,120 cu. Farmers’ revenue rises from 8,704 cu (272 at 32) to 14,720 cu (368 at 40).
• Poor harvest, Qs = 2P - 20: the free price is 70 cu (Q = 120), above the ceiling.
• At 60 cu, demand is 160 and supply 100, so the agency releases 60 tonnes and receives 3,600 cu. Stock falls from 128 to 68 tonnes.

Evaluation: the band must match the long-run price. A floor set too high builds stocks and storage costs; if stocks run out the ceiling cannot hold.

Maximum price (ceiling). A price below equilibrium to help consumers afford essentials. In Country C the rental market has Qd = 500 - 2P and Qs = 3P - 250, so P = 150 cu and Q = 200. A cap of 120 cu gives Qd = 260 and Qs = 110: a shortage of 150. Consumers would pay up to (500 - 110)/2 = 195 cu for the last unit, so black markets, queues and falling quality follow.

Minimum price. A price above equilibrium, to raise producers’ incomes or curb a demerit good. On the diagram a horizontal line above equilibrium leaves quantity supplied above quantity demanded: a surplus unless the government buys it.

5. Legislation, regulation and tradable pollution permits

Legislation and regulation set rules: bans, standards, licences, disclosure, age limits. They suit severe or irreversible harms. Diagram: a vertical line at the permitted output, left of the market quantity. Costs: enforcement, one rule for firms with different costs, and no incentive to go beyond the standard.

Tradable pollution permits. The government fixes a cap on total emissions, issues permits up to that cap, and lets firms trade them. Diagram: the permit market has vertical supply at the cap and downward-sloping demand; their intersection is the permit price, and a lower cap shifts supply left and raises it. Firms with low abatement costs cut emissions and sell spare permits; firms with high costs buy them.

Worked example. Three plants each emit 50 tonnes (total 150). The cap is 90, so each gets 30 permits. Abatement costs 4, 7 and 12 cu per tonne for plants 1, 2 and 3, and each could abate all 50 tonnes at that cost.

• Without trading each abates 20 tonnes: 80 + 140 + 240 = 460 cu.
• With trading, 60 tonnes must still be abated, using the cheapest first. Plant 1 abates 50 (200 cu), plant 2 abates 10 (70 cu), plant 3 none. Total 270 cu, a saving of 190 cu.
• The permit price settles at 7 cu: plant 1 sells 30 permits, plant 2 buys 10, plant 3 buys 20 (140 cu instead of 240 cu of abatement).

Evaluation: the cap must be set well and monitored.

Information provision corrects information failure by giving consumers facts: health warnings, nutrition labels, public campaigns. Diagram: for a demerit good, demand shifts left as consumers learn the harm, moving quantity towards the optimum. It is cheap and respects choice, but works poorly where people are short-sighted or addicted.

Competition policy aims to protect competition so firms face pressure to keep prices low and quality high. Diagram: a firm with market power sets price above marginal cost at low output; more competition moves price down and output up. Tools include fining collusion and abuse of a dominant position, assessing mergers, and opening markets to entrants. Weaknesses: investigations are slow and costly, and firms can argue that size brings economies of scale.

6. Evaluating effectiveness

Judge any method on these criteria and say which matter most in the context.

Criterion	Question to ask
Effectiveness	Does it reach the target output, price or access level?
Cost	Budget, administration, compliance, opportunity cost
Side effects	Shortages, black markets, regressive effects
Information	Can the authority measure the externality or right price?
Equity	Who gains and who pays?

A strong answer ranks the methods for the case. For pollution, a tax set at the marginal external cost is efficient in theory, yet a ban may suit a harm that must stop outright. For inequity, state provision and transfers act directly but cost taxpayers.

7. Cost Benefit Analysis (CBA)

Meaning. CBA appraises a project or policy by listing all its costs and benefits to society, private and external, valuing each in money, and comparing totals. A project passes if social benefits exceed social costs.

Steps. (1) Identify every cost and benefit, including external ones. (2) Value each in money; where no market price exists (a life saved, quiet) use estimates such as willingness to pay. (3) Discount: money received later is worth less today, so present value = amount / (1 + r)^n, with discount rate r and n years. (4) Net present value (NPV) = present value of benefits minus present value of costs.

Worked example (transport). Country D plans a tram line costing 650 million cu now. For four years, annual benefits are 260 million (time saved, fewer accidents, less congestion for others) and annual costs 50 million (running costs and an estimated cost of noise and habitat loss): net 210 million a year.

• At 5%: 210/1.05 + 210/1.05^2 + 210/1.05^3 + 210/1.05^4 = 200.00 + 190.48 + 181.41 + 172.77, about 744.65 million. NPV = 744.65 - 650 = +94.65 million, so it passes.
• At 15% the present values are 182.61, 158.79, 138.08 and 120.07, totalling 599.55 million. NPV = -50.45 million, so it fails.

The decision turns on the discount rate.

Applications. A school (lifetime earnings and spillovers against building and teaching costs), an environmental scheme (cleaner water against the cost of works), a hospital (lives saved), a railway (journey times, accidents, emissions).

Value in decisions. Strengths: it brings externalities into view and gives a common basis for comparing projects. Limitations: intangibles are hard to value, forecasts are uncertain, the result is sensitive to the discount rate, it ignores who gains and loses unless distribution is added, and decisions may be political. Use it as one input.

8. Government failure

Meaning. Government failure occurs when intervention fails to improve resource allocation, or makes it worse, so welfare is lower than it could be.

Causes.

• Imperfect information. Officials cannot know the true external cost or right price.
• Distorted incentives. Politicians favour short-term, vote-winning policies.
• Regulatory capture. The industry influences its regulator.
• Unintended consequences. Rent caps reduce supply; subsidies are captured by producers.
• Administrative and compliance costs, time lags.

Worked example. In Country A’s packaging market, suppose officials overestimate the external cost and set a tax of 9 cu (true cost 5 cu). Then 240 - 6P = 4P - 76, so P = 31.60 cu and Q = 50.4, below the optimum of 60. The new deadweight loss is 0.5 x (9 - 5) x (60 - 50.4) = 19.2 cu, against 30 cu with no tax. Welfare is still 10.8 cu better, so the failure is partial.

Consequences. Misallocation of resources, wasted taxpayers’ money, new inequities and loss of confidence. Evaluate by asking whether the result is worse than the original market failure.

Common errors

• Drawing a tax or subsidy as a movement along a curve, not a shift.
• Taking the whole tax as the price rise.
• Discounting benefits but not costs in CBA.

Official syllabus

OCR A Level in Economics (H460), Version 3.0 (June 2026), for first assessment in 2021, published by OCR. This guide covers the topics “Alternative methods of government intervention” and “Government failure” in Component 1.