The government might intervene by setting standards

The government might intervene by setting standards which restrict the amount of pollution
that can be legally dumped. The government would then need to regulate and inspect the
company to make sure several ways, for example by imposing large fines on any company
that contravenes the law.
Financial intervention can be take form of taxes and subsidies in the case of externalities. A
tax would normally be imposed on the individual or form that causes the externality. If this
happens then economists say that external costs are internalised.
Based on Figure 2.0, the government intervenes in this market and imposes a tax which is
equal to the marginal external cost. This tax is added to the cost of producing the product and
thus the supply curve
S
2
is also equal to the MPC plus tax. Besides that, the price at which
the product is sold has increased from
P
1
to
P
2
. This is less than the tax applied by the
government. The producer has accepted a cut in the price received from
P
1
to
P
3
. The
producer has borne the burden of part of the tax. The total tax paid is equal to the area

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P
2
ABP
3
, of which the consumer’s share of the burden is
P
2
ABP
1
and the producer’s
share is
P
1
ABP
3
.
Let us evaluate the form of subsidies through a graph. If the government subsidies production
of this product then the supply curve moves to the right from
S
1
, which equals MPC, to
S
2
, which equals MPC minus the subsidy. As expect, there is considerable, debate over
which is the best method of government intervention when externalities are present in a
market. If we accept the argument that education provides external benefits, then one solution
would be to provide a subsidy to education. Student still have to pay towards their education
in the form of a fee, which can be represented by
P
3
. The government provides the
difference between
P
2
and
P
3
by providing a subsidy.
The last method use by government intervention is maximum price controls and price
stabilisation. Government impose maximum price controls in markets and how in agricultural
markets price stabilisation policies can be applied. Maximum price controls are only valid in
markets where the maximum price that is imposed is below the normal equilibrium price as
determined in a free market. Government use legislation to enforce maximum prices for:
 Staple foodstuffs, such as bread, rice and cooking oil.
 Rents in certain types of housing.
 Services provided by utilities, such as water, gas and electricity companies.
 Transport fares where a subsidy is being paid.
Price stabilisation policies, especially in agricultural markets, are designed to lessen the
effects of unplanned fluctuations in supply. Although theoretically simple in terms of their
economic logic, such policies are often criticised as they do not promote efficiency and tend
to protect farmers from the full force of competition in world markets. (resources from

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Economics AS Level and A Level, University of Cambridge International Examinations,
2008)
Question 7
Outline the economic argument against
monopoly. Is there anything which can
be said in favour of firms which have
monopoly power?