25 Marker model answer AQA Economics style – government intervention

Essay question

Here is the question I with a short extract first:

The UK Government aims to have all new car and van sales be zero emission vehicles from 2035. In January 2024 the UK Government put in place a zero emission vehicle mandate. This states a minimum proportion of car manufacturers’ sales must be zero-emission vehicles, a proportion which will rise over time to 100%.

Evaluate possible methods for the government to intervene in markets with negative externalities, such as markets for petrol and diesel cars. [25 marks]

Extended essay plan

• Intro – define negative externalities and briefly explain the market failure in words; refer to real world example. Get into main body quickly.
• Analysis paragraph 1: tax, including tax diagram layered on top of externality diagram.
• Evaluation paragraph 1: depends on price elasticity of demand.
• A2: tradable allowances / permits.
• E2: governments can set the wrong number of permits / allowances.
• A3: subsidy for electric vehicles makes consumers switch away from polluting substitutes. Focus on disadvantage: funds not used.
• E3: subsidies can come with conditions.
• Conclusion: tradable allowances as the best policies. Subsidies have an opportunity cost but can be funded through tax revenue.

Model answer

Introduction

Petrol and diesel cars exhibit negative externalities of consumption, that is the harm caused by consumers using the cars on third parties. This includes increasing the level of pollution, which can cause breathing problems and contribute to climate change. So MPB exceeds MSB, as drivers may not consider how driving affects others. This leads to overconsumption of diesel cars in the free market and the welfare loss (green area below).

Analysis paragraph 1 – advantage of taxation

The Ultra Low Emissions Zone (ULEZ) in Greater London is an example of a tax on polluting vehicles. If a vehicle does not meet ULEZ emissions standards, there is a £12.50 charge per day to drive within the zone. The ULEZ tax shifts the supply curve (or the marginal private cost curve) left from MPC=MSC to MPC+tax. So the price of diesel car use increases from p to p1, reducing the incentives for consumers to buy and use diesel cars. The amount of diesel car use falls from q to q1, the socially optimal quantity where MSB = MSC. This tax thus lowers the level of pollution and increases social welfare by the area of the green triangle, making the market account for the negative externality.

Evaluation paragraph 1 – PED

However demand may be price-inelastic for some diesel car users, who depend on their car to get to work, particularly in areas with little public transport outside Zones 1 and 2. If demand is price-inelastic, then the tax will lead only to a small fall in the quantity of car journeys. So pollution would only fall to a limited extent as a result of the tax.

Analysis paragraph 2 – advantage of tradable allowances

The UK Government has a Zero-Emission Vehicle (ZEV) mandate, requiring 28% of new car sales are electric vehicles (EVs) by 2025. This limits the quantity of non-ZEV vehicles firms can produce. To avoid fines for exceeding limits on non-ZEV vehicles, firms can buy allowances. Allowances can be traded with other firms like a tradable permits system. The number of new petrol/diesel vehicles that can be sold will be capped by the government setting the amount of allowances. In the market for allowances in the diagram above, the government gradually tightens the supply of allowances from S to S1 by imposing stricter requirements on the percentage of high emission cars that can be sold. This increases the price of allowances from p to p1, increasing costs for firms who have to buy more allowances. So firms may reduce production of diesel cars. Firms may pass this on to consumers with higher prices for diesel cars, contracting demand and hence reducing pollution. This eliminates the welfare loss arising from overconsumption of diesel vehicles.

Evaluation paragraph 2 – level of allowances

However the government may lack information about the size of negative externalities associated with pollution. So the number of allowances for petrol / diesel cars may be set too low. In this case the level of pollution will be lower than the socially optimal level, with firms experiencing excessively high costs and going out of business, creating government failure and a welfare loss. The government needs to calibrate the level of allowances correctly to maximise social welfare.

Analysis paragraph 3 – disadvantage of subsidies

Another approach is to subsidise electric vehicles (EVs), a substitute good for petrol and diesel cars that create less pollution during use, to lower EV prices and encourage consumers to switch from diesel cars to EVs. A disadvantage of subsidies is firms could allocate subsidy funds towards shareholder dividends. So a subsidy may not necessarily lower the cost of production, keeping electric vehicle prices elevated. So consumers would not switch from polluting diesel cars to electric vehicles. The funds would have an opportunity cost – the government could spend them elsewhere with a higher return e.g. on healthcare. This could explain why the UK Government closed the £300 million plug-in car grant scheme to new electric cars in 2022.

Evaluation paragraph 3 – conditions for subsidy funds

However the government could require the subsidy be invested. For example the Automotive Transformation Fund subsidises UK vehicle producers provided they invest in green technologies such as EV production or battery development. This would lower costs for EV producers, lowering EV prices and encourage those on diesel cars to switch to EVs, lowering total emissions.

Conclusion

Overall tradable allowances are likely to be the most effective policy to reduce the level of pollution associated with petrol and diesel cars. Those firms who struggle to switch production to EVs can buy allowances from other firms.. Subsidies are likely to be ineffective as funds may be misused. The effectiveness of subsidies depends on the government’s budget position – subsidies can increase the budget deficit, which stands at 4.4% of GDP in 2023-4. This would increase the national debt and interest repayments, incurring a large opportunity cost and rendering subsidies less effective.

Comments on the model answer

This is a solid answer. It contains detailed analysis, evaluation and real world examples. In particular, it does the following:

• Analysis paragraphs:
  • Clear, complete chains of reasoning.
  • Use of diagrams, including a high level diagram in the first analysis point.
  • Use of real world examples in each analysis paragraph.
• Evaluation paragraphs:
  • Clear chain of reasoning as to what the previous analysis point may depend on or limitations.
  • Uses classic micro evaluation points for government intervention: elasticities (PED in this case), government failure, tailoring the policy (e.g. subsidy conditions).
  • Links back to the question.
  • Some evaluation points are supported by real world examples, while others are supported by an extended chain of reasoning using economic theory.
• Conclusion: answers the question, provides justifications and discusses a new evaluation point that the answer depends on.
• Introduction: define a key term and briefly explains the idea that pollution harms third parties.

As a result, this answer would likely score full marks or close to this.

Note that other essay structures are possible. For example, an introduction, two detailed analysis points, two evaluation points and an extended conclusion. In this case, bear in mind the conclusion and. [An answer with this structure will be provided on this website in due course].

Other possible points that could be used in this essay include, but are not limited to:

• Other possible policies, such as information provision, banning some diesel vehicles in cities (example: Paris) and defining property rights.
• Subsidies or taxes for related goods e.g. subsidies for EV chargers or taxes for petrol / diesel cars.
• Taxes: consumer and producer incidence, effect of taxes on related goods (substitutes – EVs) and so on.
• Tradable allowances / permits: their effects depend on how permits are initially assigned (an auction or “grandfathering” – based on past production / emission levels).
• Subsidies: subsidy supply and demand diagram
• Year 2 cost / revenue diagrams could also be introduced, for example to describe the effect of tradable allowances / subsidies / taxes on firms’ costs and hence profits.
• Other markets with negative externalities, such as alcohol, cigarettes, unhealthy food and some types of polluting manufacturing.

What if the exam question were different? For example, asking about whether the government should intervene?

• In this case, it will be important to first argue why the government should intervene, including discussing the market failure.
• You could also discuss the pros and cons of particular intervention methods.
• With this essay title you could also discuss how the free market can solve market failures. For example in the case of cars, consumer preferences may change over time due to increasing awareness of pollution. This would lead to consumers reducing their demand for diesel cars without intervention.

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