3.1 Reasons for government intervention in markets
- Syllabus
- 9708–2026–2027
- Topic
- 3.1
- Level
- AS
Learning objectives
Governments can provide public goods to overcome the free-rider problem
Because public goods are non-rival and non-excludable, individuals can benefit without paying, so private markets may underprovide or not provide them at all.
Government can finance provision through taxation, direct production or contracts, but must estimate demand, cost and the socially valuable quantity. Provision still has an opportunity cost.
A publicly funded flood-warning system can protect many households simultaneously; charging each household separately may fail because people can wait for others to contribute.
Public provision does not mean unlimited free supply or zero cost; scarce labour and finance are still used.
Correct under- and over-consumption of merit and demerit goods
A merit good is under-consumed when people underestimate its private benefits; a demerit good is over-consumed when people underestimate its private harms. Imperfect information means the choice made is not the choice that would be made with fuller knowledge.
| Problem | Intended correction | Policy routes | Main limits |\n|---|---|---|---|\n| Merit good under-consumption | Raise informed demand and/or lower access price | Information campaign, subsidy, maximum price, regulation or direct/free provision | Fiscal cost, excess demand, poor targeting, government misjudges desired quantity |\n| Demerit good over-consumption | Reduce uninformed demand and/or raise private cost | Information campaign, indirect tax, age/quantity restrictions or ban | Inelastic demand, addiction, evasion/black markets, regressivity, government misjudges harm |
Choose policy by mechanism. Information shifts informed demand; a subsidy shifts supply right and lowers price; an indirect tax shifts supply left/up and raises price; direct provision changes availability. Combining policies can address both knowledge and affordability, but effects depend on PED/PES and enforcement.
Risk information plus subsidised vaccination can increase informed uptake. Health warnings plus a sugar tax can reduce high-sugar drink consumption, although a small quantity response is likely when demand is price inelastic or close substitutes remain untaxed.
Merit and demerit goods are private goods, not public goods. The case for intervention must identify imperfect information and the resulting under- or over-consumption; calling a product 'good' or 'bad' is not sufficient.
Price controls create different shortages or surpluses depending on the legal bound
A maximum price set below equilibrium is a price ceiling that can create excess demand; a minimum price set above equilibrium is a price floor that can create excess supply.
The effect depends on whether the control is binding. A non-binding ceiling above equilibrium or floor below it leaves the market outcome unchanged; enforcement and allocation mechanisms determine who gains access.
A binding rent ceiling may reduce the price paid by some tenants but create a shortage and non-price allocation; an agricultural support price can create unsold surplus.
A legal price is not automatically binding, and a price ceiling does not guarantee every willing buyer can obtain the good.