2.10 – 2.11 – Market Failure and Government Intervention – IGCSE AID |
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Before we dive into what market failure is, let’s get familiar with some terms related to market failure: Public goods: goods that can be used by the general public, from which they will benefit. Their consumption can’t be measured, and thus cannot be charged a price for (this is why a market economy doesn’t produce them). Examples include street lights and roads. Merit goods: goods which create a positive effect on the society and ought to be consumed more. Examples include schools and hospitals. The opposite is called demerit goods which include alcohol and cigarettes. External costs (negative externalities) are the negative impacts on society (third-parties) due to production or consumption of goods and services. Example: the pollution from a factory. External benefits (positive externalities) are the positive impacts on society due to production or consumption of goods and services. Example: better roads in a neighbourhood due to the opening of a new business. Private costs are the costs to the producer and consumer due to production and consumption respectively. Example: the cost of production. Private benefits are the benefits to the producer or consumer due to production and consumption respectively. Example: the better immunity received by a consumer when he receives a vaccine. Social Costs = External costs + Private Costs Social Benefits = External benefits + Private benefits Market FailureMarket failure occurs when the price mechanism fails to allocate resources effectively. This is the most disadvantageous aspect to the market economy. Causes of market failure are: When social costs exceed social benefits (especially where negative externalities (external costs) are high).Over-provision of demerit goods like alcohol and tobacco: the external costs arising from demerit goods are not reflected in the market and so they are overproduced.Under-provision of merit goods such as schools, hospitals and public transport, since the external benefits of these goods are not reflected in the market, they are underproduced.Lack of public goods such as roads, bus terminals and street lights: since their consumption cannot be measures and charged a price for, they are not produced by the private sector.Immobility of resources: when resources cannot move between their optimal uses and thus are not used to the maximum. For example, when workers (labour) don’t have occupational or geographic mobility.Information failure: when information between consumers, producers and the government are not efficiently and correctly communicated. Example: a cosmetics firm advertises its products as healthy when it is in fact not. The consumers who believe the firm and use its products might suffer skin damage.Abuse of monopoly* powers: monopolistic businesses may use their powers to charge consumers a high price and only produce products they wish to, since they know consumers have no choice but to buy from them.*Monopoly: a single supplier who supplies the entire market with a particular product, without any competition. Example: public utilities like water, gas and electricity in many countries are provided by their respective governments with no other producer allowed in the market. 2.11 – Mixed Economic SystemIn a mixed economic system, both the market and government intervention co-exist. Examples include almost all countries in the world (India, UK, Brazil etc.). This is because it overrides all the disadvantages of both the market and planned (govt. only) economies. It identifies the importance of the price mechanism in operating an efficient resource allocation and also the role of the government in correcting (any) market failures. Features: both the public and the private sector existsplanning and final decisions are made by the govt. while the market system can determine allocation of resources owned by it, along with the public organizations.Advantages: The govt. can provide public goods, necessities and merit goods. The private businesses can provide profitable and most-demanded goods (luxury goods, superior goods). Thus, everyone is provided for.The govt. will keep externalities, monopolies, harmful goods etc. in control.The govt. can provide jobs in the public sector (so there is better job security).The govt. can also provide financial help to collapsing private organizations, so jobs are kept secure.Disadvantages: Taxes will be imposed, which will raise prices and also reduce work incentive.Laws and regulations can increase production costs and reduce production in the economy.Public sector organizations will still be inefficient and will produce low quality goods and services.The specific ways in which the government, in a mixed economic system, can correct market failures of the market: Legislation and regulation – the government can make laws that regulate market activity, for example, prohibit smoking in public (which would cause a negative externality). One important kind of legislation the govt. can undertake is price controls – setting a minimum price or maximum price on goods.![]() ![]() ![]() ![]() As you can see, market failure can be corrected by governments in a variety of ways and the presence of a government is quite indispensable in any modern economy. Planned (government-only) economies are too inefficient and free market (no government) economies result in market failures. So a mixed economic system tries to balance both sides. That being said, there are certain drawbacks to government intervention in an economy. Political incentives: this occurs when there is a clash between political and economics (because a government is a political entity with political incentives). For example, even though mining companies cause a lot of environmental damage, the government may encourage and promote their activities to garner political and financial support from them.Lack of incentives: in the free market, individuals have a profit incentive to innovate and cut costs, but in the public sector, such an incentive is absent since the government will pay them salaries regardless of their performance. So, even as the government provides certain public and merit goods directly to the people at low costs, they tend to be very inefficient.Time lags, information failure: these are some of the government failure arising because of a lack of incentive. Government offices and employees don’t have an incentive to provide timely services or give accurate information and this leads to very inefficient systems.Welfare effects of policies: government policies such as taxation and welfare payments distort the market. This means that such policies will influence demand and supply in the economy and cause markets to move away from the efficient points produced by a market system. For example, high corporate taxes will deter companies from expanding their operations and making more profits or deter new enterprises from entering the market. Unemployment benefits given out by the government may cause people to stay unemployed and receive free benefits instead of working.Notes submitted by Lintha Click here to go the next topic Click here to go to the previous topic Click here to go back to the Economics menu AdvertisementShare this:Click to share on Twitter (Opens in new window)Click to share on Facebook (Opens in new window)Click to share on Pinterest (Opens in new window)Click to share on WhatsApp (Opens in new window)Click to email a link to a friend (Opens in new window)Like this:Like Loading... |
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