Post on 24-Dec-2015
Government Intervention in the Market
A2 Economics
Aims and Objectives
Aim: Understand government intervention
in the marketObjectives:Define government/market failureExplain the causes of market failureAnalyse government policies to
correct mf.Evaluate government policies to
correct mf.
Starter
Define market failure.
How many causes of market failure can you think of?
Causes of Market Failure• Negative externalities
• Positive externalities
• Public goods
• Merit goods
• Demerit goods
• Imperfect competition
• Immobility of factors of production
• Equity issues (poverty and inequality)
Productive and Allocative Inefficiency
Productive Inefficiency: when firms are not producing at minimum average total cost
Allocative Inefficiency: when resources are not used to produce the goods and services wanted by consumers.
Government Intervention Methods
• Government Legislation and Regulation
• Direct provision of goods/services
• Fiscal policy
• Improving information
Government Failure Causes
•Political self-interest
•Imperfect information•Unintended consequences
•Regulatory capture
Recap: Externalities & Market Failure
The problem created by externalities is that too much or too little is being produced.
The free market fails to produce an efficient allocation of resources.
When governments intervene they wish to ‘internalise the externality’.
Positive Externalities Causing Environmental Market Failure
• Consider case of trees being planted.
• Assume only positive externalities.
• Therefore MPC = MSC
• MSC = marginal social cost
• MPC = marginal private cost
• MPB = marginal private benefit
• MSB = marginal social benefit
• MEB = Marginal external benefits
Positive Externalities Causing Market Failure
Tree planting produces positive externalities and
external benefits.
Means the MSB is greater than the MPB. (Shown by
curves).
Maximise private benefit for forestry, they plant Q1
trees where MPC=MPB.
However it is socially optimal at Q2 where MSC=MSB.
Market fails as under production and under
consumption occurs shown by Q2 minus Q1.
Negative Externalities Causing Environmental Market Failure
• Consider case of coal burning power station.
• Assume only negative externalities.
• Therefore MPB = MSB
• MSC = marginal social cost
• MPC = marginal private cost
• MPB = marginal private benefit
• MSB = marginal social benefit
• MEC = Marginal external costs
Negative Externalities Causing Market Failure
Because pollution is discharged during production the
MSC is higher than the MPC.
Power station maximises private benefit by producing
Q1, where MPC=MPB.
Socially optimal level of output is producing Q2 where
MSC=MSB.
Market forces over produce electricity by amount Q1
minus Q2.
Market fails because the power station has produced
too much electricity.
Government Intervention to Correct Environmental Market Failure
Tax the polluter
Increasing private costs of production
Incentivise producer to move towards MSC.
Reduce NE.
E.g. Congestion charging
Tax Per Unit
Government Intervention to Correct Environmental Market Failure - Problems
In groups decide reasons as to why using an environmental tax would be problematic.
Government Intervention to Correct Environmental Market Failure - Problems
Difficult to place a monetary value on the environment and externalities. Therefore problems setting monetary value to tax.
Difficult for gov to reduce pollution since they cannot be sure how firms and consumer would react to price and cost changes.
Government Intervention to Correct Environmental Market Failure - Problems
Imposing taxes on demerit goods may affect poorer in society more, who consume more demerit goods. Widen inequalities in long run.
May reduce international competitiveness or encourage firms to move to a country where there are no environmental taxes e.g. India.
Government Intervention to Correct Environmental Market Failure
Regulate the markets heavily, setting pollution quotas.
Create a market, e.g. Pollution permits
Raises money for government and extends property rights.
Plenary
How could these government intervention methods result in government failure?