Govt. Intervention To Correct Market Failure
Govt. Intervention To Correct Market Failure
What is the market failure in the first place that needs government
intervention?
• Government intervention:
• Impose taxes
• Taxes raise cost of production for firms that produce those negative
externalities. With higher costs, firms are likely to supply less.
• Government intervention:
• Provide subsidies
What is the market failure in the first place that needs government
intervention?
What is the market failure in the first place that needs government
intervention?
What is the market failure in the first place that needs government
intervention?
• Government intervention:
• State provides those public goods and merit
goods
State provision of public goods and merit goods to correct market failure
Government’s supply > market supply
• Government intervention:
• To regulate firms to provide/disclose necessary information
• To step in wherever and whenever information is imperfect
• Government failure arises when the total social costs arising from
intervention are greater than the total social benefits created by the
intervention.
Causes of government failure – overview
• Distortion of price signals
• Unintended consequences
• Excessive administrative costs
• Information gaps
• Conflicting objectives
Causes and consequences of government
failure – distortion of price signals
• E.g. of cause: Government
• Government intervenes to support domestic
farmers by imposing tariffs on agricultural Supports
imports.
• Consequences:
• Domestic consumers pay higher prices
• Farmers are growing crops that could be more
efficiently used to grow something else However, higher prices
• Consequences:
• Consumers across EU paid higher prices for
food
• Depressed world prices for certain
agricultural products. However, higher
prices for food;
• Under the CAP, the EU bought up certain products Depressed world
at minimum price, then disposed of the produce prices for agricultural
by selling it below price onto world markets. products
Causes and consequences of government
failure – administrative costs
• E.g. of cause: Government
• Government intervenes by putting in place a
scheme to help unemployed get jobs Implements
• Consequences:
• High administrative cost for every applicant
who passes through the scheme
• No guarantee that every applicant gets a job,
but still there will be administrative cost
incurred However, high
administrative costs
• Government failure may result, as those
costs may outweigh the benefits of those
who successfully get employed
Causes and consequences of government
failure – information gaps
• E.g. of cause: Government
• If markets have information failure, so too
builds
have governments
• E.g. government wants to build infrastructure
and weighs up costs and benefits
• Consequences:
• Wrong projections of costs and benefits
• This leads to making wrong policies Weighs costs vs benefits
• Consequences:
• Making such a decision (to increase spending on
defence) involves an opportunity cost.
• The welfare gain of the foregone alternative could be
higher than the welfare gain of the chosen option.
• Government failure may result, as they pick the
objective that gives lower welfare gain than the However, could have used
other objective. money elsewhere where
country can gain more
• Government may do this for reasons such as own welfare benefits
political beliefs and lack of information.
Summary
Government
Market
Market failure