Governments have four main ways to cut a negative externality. Each moves output towards the social optimum in a different way.
Four ways to correct it
Indirect or carbon tax
Add the external cost to the price, so producers or buyers pay it.
Tradable permits
Cap total pollution; firms buy and sell the right to pollute.
Legislation and regulation
Ban it, or set limits and standards, with fines.
Education and awareness
Warnings and campaigns change what people want to buy.
The points to remember
- Taxes and permits are market-based: they put a price on the harm.
- Rules and education change behaviour directly.
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Start with the tax, the policy most papers ask about.
Our example (made-up numbers)
| No tax | Tax of €4 a tonne | |
|---|---|---|
| Output | 40 | 20 (the optimum) |
| Welfare loss | Yes | None |
| Tax revenue | €0 | €80 |
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Remember it as: Tax the harm and the market finds the social optimum.
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Tradable permits put a cap on pollution and let the market set its price.
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Which policy, when?
| Policy | Strength | Weakness |
|---|---|---|
| Carbon tax | Revenue; firms choose how to cut | Hard to set the right rate; regressive |
| Tradable permits | Pollution is capped for sure | Permit prices swing; needs monitoring |
| Regulation | Simple and certain | Costly to enforce; no reason to do better |
| Education | Tackles the cause; lasting | Slow; can be ignored |
Paper 3 ends with a 10-mark Recommend question: May 2022, the specimen paper, May 2024 and November 2025 all asked for a policy against a negative externality.
Using the text/data provided and your knowledge of economics, recommend a policy to reduce the market failure caused by emissions from the cement industry.
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See the answer broken into clear points, with guidance on how each point earns marks.
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How the 10 marks are given
| Marks | What your answer needs |
|---|---|
| 9–10 | Theory used effectively, figures from the text support the analysis, balanced evaluation |
| 7–8 | Policy fully explained with theory, figures from the text applied, evaluation mostly balanced |
| 5–6 | Policy explained, some figures from the text, evaluation one-sided |
| 3–4 | A suitable policy, little theory, no figures from the text |
| 1–2 | A policy named, little more |