1.2.6 Government intervention
- Syllabus
- 2026
- Topic
- 1.2.6
- Level
- —
Learning objectives
1.2.6a Government policy to deal with externalitiesGovernment policy to deal with externalities:• taxation• subsidies• fines• regulation• pollution permits.1.2.6b Evaluating government policies for externalitiesAdvantages and disadvantages of each government policy.1.2.6c Government regulation of competitionGovernment regulation of competition to:• promote competition• limit monopoly power• protect consumer interests• control mergers and takeovers.1.2.6d Minimum-wage intervention and diagramsExplain reasons for a minimum wage and its advantages and disadvantages. Use diagrams to show the effects of introducing or increasing a minimum wage.
Trace five policies into changes in externalities
An externality is a cost or benefit affecting a third party. Government policy aims to make decision-makers face more of an external cost, encourage external benefits, or directly limit harmful activity.
| Policy | How it works | Externality route |
|---|---|---|
| taxation | adds a compulsory charge to a harmful good or activity | raises private cost and usually price, discouraging production or consumption with external costs |
| subsidy | government pays part of a producer's or consumer's cost | lowers cost and usually price, encouraging goods with external benefits or cleaner substitutes |
| fine | imposes a financial penalty when a rule is broken | raises the expected cost of harmful non-compliance and deters it |
| regulation | sets a legal rule, standard, restriction or ban | directly changes what producers or consumers may do |
| pollution permit | gives a firm the legal right to emit up to a stated amount | limits emissions through the number or quantity of permits; trade can reward firms that cut pollution where permits are transferable |
A renewable-energy subsidy can make cleaner power cheaper; a tax on a polluting product can reduce its demand; an emissions standard backed by fines can constrain firms that exceed the legal limit.
A tax is a charge on a permitted transaction or activity. A fine is a penalty for breaking a rule. A subsidy encourages an activity; it does not itself prohibit the harmful alternative.
Evaluate every externality policy with the same test
| Policy | Main advantages | Main disadvantages |
|---|---|---|
| taxation | creates a price incentive; raises revenue that can fund other action | weak effect when demand is price inelastic; may be regressive or raise business costs |
| subsidy | encourages beneficial output or cleaner alternatives; can speed adoption | opportunity cost to government; firms or consumers may receive support without changing enough behaviour |
| fine | targets rule-breakers and can strongly deter when detection is likely | monitoring and enforcement cost money; a low fine or low chance of detection may not deter |
| regulation | can set a clear minimum standard or ban severe harm | inflexible rules may impose high compliance costs; effectiveness depends on enforcement and cooperation |
| pollution permit | fixes or controls the allowed pollution total; transferable permits reward low-cost abatement | allocation and monitoring are complex; too many permits or a weak cap produces little reduction |
Judge effectiveness by asking: How large is the incentive or restriction? How responsive is behaviour? Can government observe and enforce it? What are the administrative, compliance and opportunity costs? Are there unintended distributional effects?
A policy is not effective merely because it exists. The best choice depends on the externality, information available and enforcement capacity; a coordinated policy mix may outperform any single instrument.
Revenue is an advantage of taxation, but it is not proof that the externality fell. Likewise, a cleaner outcome after regulation does not by itself prove the rule caused the whole change.
Explain why governments regulate competition
Competition regulation changes market rules or business conduct when weak competition could give firms excessive power over rivals and consumers.
| Regulatory purpose | Possible action | Intended result |
|---|---|---|
| promote competition | reduce legal entry barriers or stop exclusionary conduct | more firms can enter and compete on price, quality and choice |
| limit monopoly power | investigate abuse, impose conduct conditions or price controls where appropriate | dominant firms have less ability to charge high prices or reduce quality and innovation |
| protect consumer interests | require accurate information, fair terms, safe quality or effective redress | consumers face less exploitation and can make better choices |
| control mergers and takeovers | approve, block or attach conditions after assessing the likely market effect | prevent combinations that would substantially weaken competition |
Blocking a takeover by a firm already holding a large market share may preserve independent rivals. Making taxi-market entry easier may increase availability and put downward pressure on fares.
A large market share can trigger scrutiny, but size alone does not prove consumer harm. Regulators compare likely benefits and costs, including whether a merger creates efficiencies as well as whether it reduces rivalry.
Read the minimum-wage diagram and evaluate its effects
A minimum wage is the lowest wage rate employers may legally pay. Governments may introduce or raise it to protect low-paid workers, reduce wage inequality and improve living standards.
| Diagram step | Labour-market result |
|---|---|
| find the intersection of labour demand and labour supply | equilibrium wage We and employment Qe |
| draw minimum wage W1 above We | the wage floor is binding |
| read labour demand at W1 | firms demand the smaller quantity Qd |
| read labour supply at W1 | workers supply the larger quantity Qs |
| compare Qs and Qd | excess supply of labour, or unemployment, equals Qs − Qd |
| raise an already binding minimum wage | Qd falls and Qs rises, so the unemployment gap normally widens along unchanged curves |
unemployment gap=Qs−Qd
| Possible advantages | Possible disadvantages |
|---|---|
| higher pay and living standards for workers who keep their jobs | higher wage costs may reduce employment, hours or hiring |
| narrower low-pay income gap | some workers seeking jobs may remain unemployed |
| stronger motivation, retention and possibly productivity | firms may raise prices, accept lower profit, automate or relocate |
| higher household spending and tax receipts | effects may spill into lower output, spending or tax receipts if unemployment rises |
The outcome depends on how far the wage floor exceeds equilibrium, the share of workers affected, labour-demand responsiveness, firms' ability to raise productivity or prices, and the time period.
A minimum wage below equilibrium is non-binding and need not change wage or employment. Qs − Qd is the diagram's unemployment gap, not a claim that every affected worker loses a job.