The use of indirect taxation, subsidies, price controls, state provision and regulation, the extension of property rights and pollution permits to correct market failure
Governments use tools like taxes, subsidies, and rules to fix markets that produce the wrong amount of a good. Each tool targets a specific type of market failure.
Formula
Social Optimum: MSC = MSB (or MPC + tax = MSB)
Real World
The UK Emissions Trading Scheme issues a limited number of carbon permits to heavy industry — firms like Tata Steel must buy extra permits if they exceed their allowance, raising the private cost of pollution to reflect its social cost.
Exam Focus
For every intervention, draw the externality diagram and show how the tool shifts supply or demand to the socially optimal output — never describe without a diagram.
Price Elasticity of Demand
PED = % change in quantity demanded ÷ % change in price
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