Cambridge International as and a level Economics Ebook

Introduction
An introduction to market failure and government 
intervention was provided in 
Chapters 1
,
 3
 and 
6.
Th
is 
chapter builds upon this introduction by considering 
policies that might be used by governments to achieve a 
more effi
cient allocation of resources.
As economies grow and develop, then it becomes 
increasingly diffi
cult for the unfettered or free market 
mechanism to work to achieve the best allocation of 
resources. Th
is does not mean that the market mechanism 
is not important. It is, but if markets are to achieve what is 
their purpose, then they must be supported by government 
policies to correct their failings.
A common form of government intervention is 
through various types of indirect taxation and subsidy, 
the basis of which was explained in 
Chapter 3.
In this 
chapter, we shall see how indirect taxes and subsidies are 
widely used to correct market failure and to provide a 
more effi
cient allocation of resources. We shall also look at 
a range of other policies that are available for governments 
to use to achieve the same objectives.
Deadweight loss
As seen in
 Chapter 6
, government intervention in markets 
is justifi ed where allocative effi
ciency is not being achieved. 
Going back to the simple analysis of markets in 
Chapter 2
, 
the demand curve represents the benefi ts that consumers 
derive from consuming a good as measured by the prices 
they are willing to pay. For this reason, the demand curve 
is also known as the marginal private benefi t (MPB) curve. 
Th
e supply curve shows the fi rm’s costs of production; 
these are marginal costs, hence the supply curve is also 
known as the marginal private cost (MPC) curve. If there 
are no externalities present, then the best outcome is at 
price 
P
e
and output 
Q
e
shown in
 Figure 8.1
. Any variation 
from this optimum will be a situation of market failure or 
allocative ineffi
ciency.
Market failure can also be understood through an 
economic concept known as 
deadweight loss
. Th
is term 
refers to the loss of economic welfare due to the fact that 
potentially desirable production and consumption does not 
take place. Th
ere is not as much producer and consumer 
surplus as there would be if all such desirable trade took 
place. Th
is loss of surplus is called ‘deadweight loss.’