Professional Documents
Culture Documents
Market Failure and Government Intervention
Market Failure and Government Intervention
Market Failure and Government Intervention
• Where markets work efficiently, the market mechanism produces the best
allocation of resources
• In reality, this doesn’t always happen, and in this case, market failure
occurs
• Therefore, only when Allocative and productive efficiency are present can
we conclude that scarce resources are being used in the most efficient
way, from a consumer’s standpoint
• Inefficiency is therefore when resources are not being used in the best
possible way
• The products that people want aren’t being produced in the quantity that
they desire at the prices that they are willing to pay
Information Failure
• Increasingly, through things like the internet, we are provided with a mass
of information about the products we want to buy.
• Also, better labelling on products such as good and drink help base our
purchasing decisions
• Other products like tobacco and alcoholic drinks may contain information
to limit or stop the consumption of a product
o Health Care – when you visit your doctor, you don’t have the same
medical knowledge as them. You therefore rely on the doctor’s
experience and knowledge to give you the treatment you need.
o Environment – As individuals, we know very little about the
environmental consequences of driving cars or tipping waste.
Environmental experts are more aware of these effects due to their
own research.
• In these examples, the lack of accurate information has distorted how the
market allocates resources
Externalities
o They fall on third parties instead of those responsible for the action
• A problem therefore arises when the private costs or benefits do not equal
the social costs or benefits
• The external costs or benefit distort the efficiency allocation of resources
• It is for this reason that the market fails to produce the best allocation of
resources
Negative Externalities
• This means that there are costs imposed on a third party over and
above the costs directly paid for by those who carry out the activity
S1
Positive Externalities
• Market can fail in the provision of merit goods and demerit goods
• The problem when categorizing merit and demerit goods is that value
judgements have to be made – it’s a subjective process
• They think that it is the individual and not the government that knows
what’s best for them
• This contradicts the view that the government knows better due to greater
information at their disposal
Public Goods
• Non excludability means that the good is provided for all irrespective of
whether they have paid for the product indirectly through taxation
• People that use public goods but haven’t paid for its provision are called
free riders
• In the real world, not all public goods possess both characteristics to the
same extent
• There are two types of method that the government can take:
Taxation
• The burden of tax is roughly evenly split between direct and indirect
taxes
prices
S1
• The graph shows the outcome when a new tax, t,
S is imposed on this type of product.
P2
B
• This means that less will be demanded and
D supplied as the market price has increased
Q1 Q
Quantit
y • The area A represents the consumers’ share of
the tax burden
• In principle, the tax that’s imposed should equal; the value of the negative
externality
• When this occurs, the producer is required to pay the tax in full
• Prices charged therefore take into account the cost of the negative
externalities
• This is fine in theory, but difficult to apply in practise for four reasons:
o There are problems determining the exact amount of the tax, as it’s
difficult to estimate the monetary cost of a negative externality
o Producers may not always pay the full amount of the tax, and it’s
often shared with the consumer
Subsidies
• Such payments are particularly relevant in the case of merit goods and
where products generate positive externalities
• In all such cases, if left to the free market, there would be under-
production and under-consumption.
Price
S
• In some respects, the subsidy’s the opposite of
S1
an indirect tax
P
• The government use other methods to correct market failure that doesn’t
involve the direct use of the price mechanism
• All such controls are used by the government to combat market failure
• In theory, the standards set should achieve what the legislation see as an
optimum scale of activity or use
• If, for example, standards are too low, the polluter receives benefits that
are greater than the external costs of the pollution caused
• The permits can be bought and sold at an agreed price between the owner
and purchaser
• If firms don’t have sufficient permits to cover their pollution, they will be
prosecuted.
Price of permits
S
• The graph shows how the price of permits is
determined in theory
• Via this, it is hoped that consumers will receive truthful and impartial
information