Allocation of Resources · 4 question types
Past paper frequency (2018 to 2024)
This topic accounts for approximately 11% of your exam marks.
Externalities and market failure corrective policies are increasingly tested; particularly in evaluate questions since 2020.
Positive externalities require the opposite policy mix: encourage more production and consumption.
A subsidy is a payment from the government to the producer per unit of output. The subsidy lowers the producer's effective cost, shifts the supply curve to the right, lowers the market price and raises the quantity sold. This boosts the production of goods that generate positive externalities (e.g. solar panels, electric vehicles).
Like a tax, a subsidy is shared between producer and consumer. The split depends on price elasticity of demand: an elastic good's subsidy mostly reaches consumers as a lower retail price; an inelastic good's subsidy is mostly retained by producers.
The government can simply provide the good itself, free at the point of use, funded through taxation. This is common for education and basic healthcare. State provision guarantees that everyone can access the good regardless of ability to pay, capturing the positive externality fully.
Just as information campaigns can discourage negative-externality consumption, they can encourage positive-externality consumption: public-health campaigns urging people to be vaccinated, to take up free screening, or to attend further education.