CIE A Level Economics 3 Government Microeconomic Intervention Exam Questions

About CIE A Level Economics 3 Government Microeconomic Intervention

Topic 3 is the AS Level section of the Cambridge 9708 syllabus on why and how governments intervene in individual markets. It builds directly on topic 2: you use demand and supply diagrams to show maximum and minimum prices, specific and ad valorem taxes, subsidies, direct provision of goods and services, and nationalisation and privatisation. The tax and subsidy analysis includes incidence on consumers and producers and how PED and PES affect it. You also study the difference between income and wealth, equity and equality, and the policies used to reduce inequality. Examiners often test tax incidence on a diagram and ask you to evaluate whether a policy will achieve its aim.

What you need to know

• 3.1 Reasons for intervention Governments intervene to provide public goods, encourage merit goods, discourage demerit goods, control prices in essential markets and reduce inequality. Information failure and the unequal distribution of income are key justifications.
• Maximum and minimum prices A maximum price set below equilibrium causes excess demand, possible queues and black markets. A minimum price set above equilibrium causes excess supply, as with some agricultural price floors and minimum wages.
• Indirect taxes A specific tax shifts supply up by a fixed amount per unit; an ad valorem tax is a percentage of price, so the curves diverge. The incidence falls more on consumers when demand is price inelastic relative to supply.
• Subsidies A subsidy shifts supply down by the subsidy per unit, lowering price and raising output. The benefit is split between consumers and producers according to relative elasticities; the cost to government is subsidy per unit x quantity.
• Direct provision and ownership Governments may provide goods directly (free at point of use), nationalise industries or privatise them. Privatisation may raise efficiency through the profit motive but can create private monopolies needing regulation.
• 3.3 Income and wealth inequality Income is a flow and wealth is a stock. Equity means fairness and equality means the same shares. Policies include progressive taxes, transfer payments, minimum wages and state provision of education and health.

Common mistakes in 3 Government Microeconomic Intervention

• Drawing a maximum price above equilibrium and claiming it causes a shortage. A maximum price only has an effect when it is set below the equilibrium price.
• Saying a tax is paid entirely by consumers. The incidence is shared and depends on the relative price elasticities of demand and supply.
• Showing an ad valorem tax as a parallel shift. A percentage tax causes a non-parallel shift because the tax per unit rises as price rises.
• Using equity and equality as if they meant the same thing. Equity is about fairness, which may justify unequal outcomes; equality means equal shares.
• Evaluating policies only with a list of benefits. Strong answers also discuss government failure, cost to the budget, unintended effects and elasticity.

Try three 3 Government Microeconomic Intervention exam-style questions