Government Intervention in the Market A2 Economics Government Intervention in the Market

Aims and Objectives Aim: Understand government intervention in the market Objectives: Define government/market failure Explain the causes of market failure Analyse 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 MSC = marginal social cost MPC = marginal private cost MPB = marginal private benefit MSB = marginal social benefit MEB = Marginal external benefits Consider case of trees being planted. Assume only positive externalities. Therefore MPC = MSC

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 MSC = marginal social cost MPC = marginal private cost MPB = marginal private benefit MSB = marginal social benefit MEC = Marginal external costs Consider case of coal burning power station. Assume only negative externalities. Therefore MPB = MSB

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?