Why and how governments intervene in markets: Maximum prices, road pricing, pollution permits and other interventions

Overview

Binding maximum prices and the excess demand they cause, road pricing, tradeable pollution permits, price stabilisation and guaranteed minimum prices, and the tax, benefit and minimum wage tools used against inequality.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   A government sets a maximum rent of £800 per month in a city where the equilibrium rent is £600. What happens to the rental market?

   Model answer

   Nothing changes — the maximum price is ineffective because it is set above the equilibrium price, so the market continues to operate at £600.

2. 2

   What condition must be met for a price ceiling to be described as 'binding' or 'effective'?

   Model answer

   The maximum price must be set below the free market equilibrium price.

3. 3

   Explain why an effective maximum price leads to excess demand.

   Model answer

   At the lower price, quantity demanded exceeds quantity supplied, creating a shortage.

4. 4

   What is road pricing and what is its purpose?

   Model answer

   Using the price mechanism to reduce congestion by charging drivers for using roads, particularly at peak times.

5. 5

   Define tradeable pollution permits.

   Model answer

   Licences issued by the government that allow firms to emit a specified quantity of pollution, which can be bought and sold in a market.

6. 6

   How do tradeable pollution permits incentivise firms to reduce emissions?

   Model answer

   They create a market for pollution rights, so firms are incentivised to reduce emissions if the cost of abatement is less than the permit price.

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