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Government intervention to reduce market failure?

Explain ways a government could intervene to reduce market failure.

Category:

CIE October/November 2023.

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Answer

Title: Government Intervention as a Solution to Market Failure

Introduction

Market failure is a situation in which the allocation of resources in an isolated, free-market scenario does not optimise overall economic efficiency. Common causes include the presence of externalities, monopolies, and public goods; situations where the market mechanism does not account for the full societal cost or benefits of economic activities. To address these inefficiencies, governments can engage in several interventions.

Subsidising Merit Goods

Merit goods, such as education or healthcare, create positive externalities, which are advantages to society. However, because private consumers often undervalue these benefits, these goods can be under-produced in a free market. Government subsidies can make these goods more affordable, thus promoting consumption and production. Through this intervention, society can better appreciate the wider benefits that merit goods bring.

Taxation on Demerit Goods

Contrary to merit goods, demerit goods like cigarettes or alcohol are over-produced in a free market due to their harmful effects that aren't reflected in their prices. These goods cause negative externalities. By imposing a tax on these goods, governments can increase their market price, thus discouraging excessive production and consumption. This intervention reduces the social cost inflicted by demerit goods.

Price Controls

Government could intervene by implementing price controls such as maximum prices on merit goods to boost consumption and minimum prices on demerit goods to minimise consumption. This adds an extra dimension to the demand-supply dynamics, thereby assisting in achieving societal welfare.

Production of Public Goods

Public goods are not typically provided by the private sector as they are non-rivalrous and non-excludable, meaning they can't generate profit. However, public goods like street lighting are crucial to society. Government intervention can finance the production of these goods, thus ensuring societal needs are met.

Regulation of Monopolies

Monopolies can cause market failure by exploiting their market power to restrict output and raise prices. Governments can intervene using regulatory policies to prevent monopolies from using this power unfairly, promoting a more competitive and efficient market.

Education, training and public information campaigns

By providing education and training, governments can increase labour mobility, reduce unemployment and boost productivity in the economy. A well-informed public is more likely to consume and produce merit goods, and less likely to consume and produce demerit goods.

Conclusion

Through a combination of tax policies, subsidies, regulation and the provision of public goods and services, governments can intervene effectively and enhance societal welfare. Thus, government intervention plays a fundamental role in relieving the shortcomings inherent in purely market-driven economies. However, it's crucial that governments employ these measures sensibly and avoid potential policy failures, which can exacerbate market inefficiencies.

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