BUSS1040 · Economics For Business Decision Making
Market Interventions & Market Failures
Topic 9 is the other heavy micro chapter and a big share of the hard 80%. It covers what happens when something distorts the competitive market: price ceilings (shortage) and floors (surplus); taxes and subsidies, where you find the new quantity from the wedge Pb − Ps = t, split incidence by relative elasticity, and measure the DWL triangle; and market failures — negative and positive externalities fixed by a Pigouvian tax/subsidy, public goods (vertical summation), and tradeable pollution permits. It is examined as multi-part calculation plus the recurring incidence-and-elasticity reasoning.
What this chapter covers
- 011. Price ceiling below P* ⇒ shortage (Qd > Qs); price floor above P* ⇒ surplus (Qs > Qd)
- 022. Per-unit tax: the wedge Pb − Ps = t; new quantity from Qd(Pb) = Qs(Ps)
- 033. Tax incidence: split by relative elasticity — the more inelastic side bears more (independent of statutory side)
- 044. Tax DWL = ½ × t × (Q* − Qt); more inelastic market ⇒ smaller DWL
- 055. Per-unit subsidy: lowers price paid below price received by s; over-production DWL
- 066. Negative externality: SMC = MC + MEC; efficient q where demand = SMC; Pigouvian tax = MEC
- 077. Positive externality: SMB = PMB + MEB; efficient q where SMB = MC; subsidy = MEB
- 088. Public goods (non-rival, non-excludable): demand summed vertically, provide where ΣMB = MC; tradeable permits hit a target at least cost
Per-unit tax: quantity, incidence and deadweight loss
- 2 marksNo-tax equilibrium: 60 − Q = 2Q ⇒ 60 = 3Q ⇒ Q* = 20, P* = 40.
- 2 marksWith a $9 tax on sellers, buyers pay Pb = Ps + 9. Set Qd(Pb) = Qs: demand price 60 − Q must equal supply price 2Q + 9, so 60 − Q = 2Q + 9 ⇒ 51 = 3Q ⇒ Qt = 17.
- 1 markPrices: Pb = 60 − 17 = 43; Ps = 43 − 9 = 34.
- 1 markIncidence: buyers bear Pb − P* = 43 − 40 = $3; sellers bear P* − Ps = 40 − 34 = $6. Sellers bear more, because supply is the more inelastic side here.
- 2 marksDWL = ½ × t × (Q* − Qt) = ½ × 9 × (20 − 17) = ½ × 9 × 3 = $13.50.
Key terms
- Price ceiling / price floor
- A legal maximum or minimum price. A binding ceiling (below P*) creates a shortage because quantity demanded exceeds quantity supplied; a binding floor (above P*) creates a surplus because quantity supplied exceeds quantity demanded.
- Tax wedge
- A per-unit tax drives a gap between the price buyers pay and the price sellers receive: Pb − Ps = t. The new traded quantity solves Qd(Pb) = Qs(Ps), reducing the quantity below the no-tax equilibrium.
- Tax incidence
- How the burden of a tax is shared between buyers and sellers. It is determined by relative elasticity — the more inelastic side bears the larger share — and is independent of which side the tax is legally collected from.
- Deadweight loss of a tax
- The lost total surplus from the reduced quantity: DWL = ½ × t × (Q* − Qt). For a given tax, a more inelastic market has a smaller DWL, which is why taxing inelastic goods minimises efficiency loss.
- Externality (and the Pigouvian fix)
- A cost or benefit imposed on third parties. With a negative externality, social marginal cost SMC = MC + marginal external cost, so the market over-produces; a Pigouvian tax equal to the marginal external cost restores the efficient quantity (where demand = SMC). A positive externality (SMB = PMB + marginal external benefit) is under-produced and corrected by a matching subsidy.
- Public good
- A good that is non-rival (one person's use does not reduce another's) and non-excludable (you cannot stop non-payers). Market demand for a public good is summed VERTICALLY (add the marginal benefits at each quantity), and the efficient level is where ΣMB = MC.
- Tradeable pollution permits
- A cap-and-trade scheme that fixes total pollution and lets firms trade the right to emit. It achieves the target at least total cost regardless of the initial allocation, because high-abatement-cost firms buy permits while low-cost abaters sell and cut more.
Market Interventions & Market Failures FAQ
Does it matter whether a tax is placed on buyers or sellers?
Not for the economic outcome. Whether the tax is legally collected from buyers or sellers, the equilibrium quantity, the prices paid and received, and the split of the burden are identical — the statutory side does not change the economics. What DOES determine who really bears the tax is relative elasticity: the more inelastic side (the one that responds least to price) bears the larger share. So a tax 'on sellers' can still fall mostly on buyers if demand is more inelastic than supply.
How do I find the new quantity and prices after a per-unit tax?
Use the wedge Pb − Ps = t. Write demand as a price (the most buyers will pay for quantity Q) and supply as a price (the least sellers will accept), then impose that the buyer's price exceeds the seller's by t: Pd(Q) = Ps(Q) + t. Solve for the taxed quantity Qt, then back out Pb from demand and Ps = Pb − t. Finally, DWL = ½ × t × (Q* − Qt) using the fall in quantity from the no-tax equilibrium.
What is the Pigouvian tax for a negative externality, and at which quantity?
A negative externality means production imposes a marginal external cost (MEC) on others, so the social marginal cost SMC = private MC + MEC lies above the supply curve. The market produces where demand = MC (too much); the efficient quantity is where demand = SMC. The Pigouvian tax sets the tax equal to the marginal external cost AT the efficient quantity, so that private MC + tax = SMC there, pushing the market to the socially optimal output. A positive externality is the mirror image: subsidise by the marginal external benefit to raise output to where SMB = MC.
Why are public goods summed vertically while private goods are summed horizontally?
For a private good, each buyer chooses their own quantity at the market price, so you add quantities at each price (horizontal summation, Topic 3). A public good is non-rival: everyone consumes the SAME quantity simultaneously, and the social value of one more unit is the sum of everyone's marginal benefit for that unit. So you add the marginal benefits at each quantity (vertical summation) and provide where the summed marginal benefit equals MC: ΣMB = MC. Because of free-riding (non-excludability), the market under-provides public goods, which is the rationale for government provision.
How is Topic 9 examined?
As a major multi-part short-answer block and many MCQs: compute the effect of a price ceiling/floor (direction and size of the shortage or surplus); solve a tax or subsidy for quantity, prices, incidence and DWL; find the efficient quantity and Pigouvian tax/subsidy for an externality; and reason about public goods and tradeable permits. The incidence-and-elasticity logic (more inelastic side bears more; more inelastic market has smaller DWL) is a recurring high-value idea, and this chapter sits squarely in the heavily weighted Topics 6–12.
Exam move
Build a single template for every intervention: identify the distortion, find the new quantity, then compute surplus/incidence/DWL. For taxes and subsidies, anchor on the wedge (Pb − Ps = t or s), solve for Qt, split incidence by relative elasticity (more inelastic side pays more), and use DWL = ½ × t × ΔQ — and always sanity-check that buyer + seller incidence sums to the tax. For externalities, draw the private and social curves, mark the market q (demand = MC) and efficient q (demand = SMC for negative, SMB = MC for positive), and set the Pigouvian tax/subsidy equal to the external marginal effect at the efficient quantity. Memorise the two summation rules (private = horizontal, public = vertical) and the least-cost property of tradeable permits. Drill the elasticity-and-incidence reasoning, because it is the single most reused idea in this high-weighted chapter.
