Using an appropriate externalities diagram, explain why a government might decide to impose a price floor on a demerit good.

Evaluate the view that the most effective way in which the government can discourage the consumption of demerit goods is through government regulations.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definition of demerit good, price floor
• diagram to show a negative externalities of consumption diagram with a price floor (minimum price) shown
• explanation of why a government might place a price floor above the equilibrium price in the market for a demerit good, in terms of negative externality arguments, and reducing consumption
• examples of price floors being imposed on demerit goods in practice.

NB If students attempt to provide two different diagrams, one for a price floor and one for negative externalities, they should be credited in the same way one diagram might be.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definition of demerit goods, government regulations
• diagram to illustrate reduction of negative externalities eg tax diagram or a change in demand due to the enforcement of regulation
• explanation of how regulation could discourage the consumption of demerit goods
• examples of government regulations on demerit goods in practice
• synthesis and evaluation.

Evaluation may include: advantages and disadvantages of government regulations; consideration of alternatives such as minimum prices, taxation, negative advertising.

Most candidates were able to draw an appropriate externalities diagram to which they applied a price floor set above the free market equilibrium. Some chose to use two separate diagrams, which was acceptable. Most candidates could provide a solid explanation of why a price floor might be applied in this case.

Candidates were not always clear about what represents a government regulation. The syllabus describes indirect taxation, in the relevant paragraph, as a market-based policy, and regulation, a ban and so forth, as being distinct from market-based policies. By declaring indirect taxes to be regulations some candidates restricted their ability to effectively address the question. Responses that clearly identified what regulations are tended to provide the best real-world examples as a result.