🚭 Banning
Banning smoking indoors in public places. This protects third parties from the smoke of a demerit good.
Mixed Economic System » Regulation and Direct Provision
What you'll learn this session
Study time: 30 minutes
Cambridge spec: 2.10.3
- What regulation is, with examples
- The advantages and disadvantages of regulation
- What direct provision of goods and services is, with examples
- The advantages and disadvantages of direct provision
🔒 Unlock Full Course Content
Sign up to access the complete lesson and track your progress!
Unlock This CourseRules and direct provision
Governments do not only change prices and costs. They can also tell firms and people what they must or must not do, and they can produce things themselves. This lesson covers two more ways of dealing with market failure.
Key terms:
- Regulation: laws and rules made by the government that control what firms, workers or consumers can do.
- Direct provision: when the government itself produces a good or service and supplies it to people, usually paid for from taxes.
Regulation
Regulation works by making an action illegal, limiting it, or setting a standard that must be met. Here are some examples.
🏭 Limiting
Pollution limits on factories. A firm may only release a set amount of waste into the air or a river.
⚖ Competition rules
Rules that stop firms joining together to fix prices, or stop a large firm from abusing its market power.
📝 Standards
Rules that products must be safe, or that food must be labelled clearly, so buyers are protected.
Remember that external costs are costs to third parties. Regulation tries to stop these costs at source, instead of changing the price.
Advantages and disadvantages of regulation
✅ Advantages
It can stop harmful activity directly. A ban means the good is not consumed at all, which a tax cannot promise.
It can protect people who have little information, such as buyers of unsafe products.
Making a rule can be cheaper than paying a subsidy or running a service, although enforcing it still has a cost.
Competition rules help stop firms abusing monopoly power.
❌ Disadvantages
Rules must be checked and enforced. Inspectors and courts cost money.
Firms may break the rules if they think they will not be caught.
Firms face extra costs to meet the rules, and may pass them on in higher prices.
Strict rules can reduce choice for consumers, or cause firms to close or move abroad.
Banned goods may be sold illegally.
Worked example
The government of the made-up country of Verdana sets a limit on the smoke a cement factory may release. The factory must fit a filter costing $500,000.
Advantage: the smoke, an external cost, falls, so nearby families breathe cleaner air.
Disadvantage: the filter raises the factory's costs, so the price of cement may rise, and inspectors must be paid to check the limit is kept.
Direct provision
Sometimes the market provides too little of a good, or none at all. Then the government may step in and provide the good itself. It employs the staff, owns the buildings and decides how much to supply.
- Street lighting: a public good, which private firms would not provide because of the free rider problem.
- State schools: education is a merit good, so providing it for free means that more children learn.
- Public healthcare: a merit good, which people of all incomes can use, even when they could not pay.
This is not the same as the government paying a subsidy to a private firm. In direct provision the government itself runs the service.
Advantages and disadvantages of direct provision
✅ Advantages
Public goods that the market would not supply are provided.
Merit goods can be free or cheap, so people on low incomes can use them.
The government can choose to put the needs of society first, instead of profit.
It can raise the use of goods with external benefits.
❌ Disadvantages
It is paid for by taxpayers, and the money has an opportunity cost.
The government may not know what consumers want, so supply may be too high or too low.
There may be less pressure to keep costs low, because there is no competition and no profit motive.
There can be queues or shortages if the budget is too small.
Worked example
The government of Kestoria builds and runs a free public clinic in a poor rural region. Private firms would not open one, because few patients could pay.
Advantage: families who could not afford a private doctor can be treated.
Disadvantage: the clinic costs $3 million a year, paid from taxes, and that money cannot be spent on new roads.
Common mistakes
- Writing that regulation is a tax or a price. It is a rule or law, so it is not a payment.
- Mixing up direct provision and a subsidy. In direct provision the government runs the service. A subsidy is a payment to private producers.
- Giving an advantage without saying who benefits. Name the person or group, such as third parties or low income families.
- Forgetting that rules need enforcing, and that provision needs taxes.
Exam-style question
The government of the made-up country of Dalvoria is worried about the noise and fumes from older diesel lorries in its capital city. It is considering a law that bans these lorries from the city centre. Separately, it plans to build and run a free bus service for city residents.
(a) Define "regulation". [2 marks]
(b) Explain one disadvantage of banning older lorries from the city centre. [3 marks]
(c) Discuss whether direct provision of a bus service by the government is a good way to deal with the city's problems. [6 marks]
Model answer
(a) Regulation is the use of laws and rules by the government (1) to control what firms or people may do (1).
(b) Lorry firms may face extra costs to buy newer lorries or to use other routes (1). They may pass these costs on in higher prices for the goods they carry (1). The ban also needs to be enforced, which costs the government money for inspectors (1).
(c) A free bus service could reduce the number of cars and lorries on the roads (1), which cuts fumes and noise, benefiting third parties (1). It lets people on low incomes travel, even if they cannot pay (1). However, the service is paid for from taxes, which have an opportunity cost (1). The government may not know how many buses are needed, so there could be waste or crowding (1). With no competition, there may be less reason to keep costs low (1). It is a good way if enough people switch to buses, but it may work best alongside rules (1).
Exam tip
In part (c), give both sides, then end with a judgement that uses the context of the question: say what it depends on.