A2 Economics. Aim: Understand government intervention in the market Objectives: Define government/market failure Explain the causes of market failure.

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?