1.5.2 Government intervention and market failure

Four reasons why the government may choose to intervene in the market and explain
Click the card to flip 👆
1 / 11
Terms in this set (11)
1- where goods are producing negative externalities
2-where goods with external benefits are being underproduced and underconsumed
3-where goods with external costs are being over produced and overconsumed
4-when businesses are using anti-competitive behaviour to reduce competition in markets and as a result consumers are losing out
1) Regulation- legal and other rules that apply to organisations.
2)Legislation- passing new laws to restrict activities that create negative
externalities and over-consumption.
3) Indirect taxation- can increase the price of products that are over-
produced, making them more expensive to consume and reducing
demand e.g. sugar tax.
4) Grants and subsidies- make under-consumed products cheaper and
encourage increased consumption.
5) Voluntary agreements- work well when there is widespread
agreement on the need for change.
In the free market, supply doesn't account for the external cost to
society when the good is produced and consumed. Therefore prices are
below the social cost and equilibrium price and output is at p1, q1.
If suppliers are charged an indirect tax that reflects the external cost, the
prices will be charged that reflect the full social cost (shown by
supply +tax curve). This would lead to a lower level of demand and a
new equilibrium at p1, q1 where the SB=SC and the socially optimal level
of output it reached.
In the free market, consumers don't account for the external benefits to
society when a good is produced and consumed. Therefore prices that
consumers are will to pay are below the social benefit at equilibrium p,q
and the good is underproduced and under consumed. If the government
subsidises the production of the good or service, then suppliers will not
have to pay the full production costs, so essentially their costs will fall.
This will lead them to charge lower prices at all output levels, shown by
s+subsidy. This will increase demand and as a result a new equilibrium
p1, q1 will be reached, where SB=SC and the socially optimal level of
output is reached.
The government can try to persuade businesses within a specific
industry to change the way they pen ave and adopt common codes of
practice that reduce harmful externalities.
This can be effective but the danger is that not all businesses will sign up,
particularly if it involves extra costs and subsequent loss of price,
competitiveness. They are most successful when the industry belleves
that worse regulations will follow if they don't agree now
1) Legislation; smoking bans in public places, age limit, packagine.
2) Advertising and education, teaching in schools, adverts on the health
3) Indirect taxes; cigarettes are one of the most highly taxed consumer
4) Free provision of alternatives to cigarettes and attendance at courses
to quit e.g. nicotine patches/e-cigarettes.
1) Governments will not always have all of the information needed to
make the best decision.
2) Sometimes governments will decide upon popular policies that have
not actually been properly thought through. Sometimes politics will
trump effective decision making.
3) Some government departments and other bodies responsible for
implementing policies do not move sufficiently far or fast to solve the
worst problems.
Explain three unintended consequences of government intervention.1) Distortion of price signals: Sometimes indirect taxes or subsidies, if not at the correct level will lead to the reverse problem as the price is made too low or two high. 2) Unintended consequences: it can be hard to predict the impact of a policy in advance, and its impossible to predict future shocks. Therefore any policy may lead to unintended consequences due to other changes in the economy at the time. 3) Excessive administrative costs; monitoring compliance in particular, can be extremely costly as monitoring systems will have to be put in place. This can end up costing more than the system in the first place.