1. Market Failure and Government Intervention

2. Why does the government intervene?
The free market is not always able to achieve allocative efficiency. – Market Failure
An allocative efficient point is where
All resources are allocated to their most efficient use
All markets are in equilibrium
The economy is operating on its production possibility curve.
It is not possible to make someone better off without making someone else worse off (Society’s well being is maximised)
This situation is also called Pareto efficiency
We will be looking at situations where it is possible to make someone better off without making someone else worse off.
This is when governments intervene in the market.

3. Conditions for the market to achieve allocative efficiency
Requires clear price signals
There must be
Perfect Competition
Perfect Information
Perfect Mobility
Consumer Sovereignty
No Externalities or public goods
Reading Price Signals

4. Market Failure Market Failure can occur from any of the following
The existence of imperfect market structures
Externalities
Public Goods
Merit and Demerit goods
Situations where the market leads to inequitable (unfair) outcomes

5. Market Failure Markets can fail in a number of ways
Some products may be under produced or not produced at all. ie parks
Some products may be produced or over produced but are not wanted by society
ie drugs
The production and consumption of some products affect third parties.
ie pollution and smoking cigarettes.
The distribution of market income may not enable all citizens to participate meaningfully in society

6. Market Failure
Market failure provides governments with the reason to intervene in the economy or in particular markets that are failing.
Government intervention aims to overcome the failure of markets to move towards a more allocatively efficient position

8. Government Intervention
Four functions of the government
1. Legislative/Regulator Role
Legal Framework
Providing a framework so buyers and sellers know their rights and obligations – enables fair dealing. Legal system used to clarify, define and enforce property rights.
Promoting Competition
Commerce Commission.
Correcting for externalities

9. Government Intervention
2. Allocative Role
Governments allocate resources that the market fails to produce in sufficient quantities
3. Distributive Role
Governments aim to promote equity (fairness) This may be done through redistribution of incomes
4. Stabilisation Role
Government aims to provide a stable economic environment

10. Indicate which Government Function is being done when….
cuts taxes to reduce unemployment
specifies that a manufacturer is liable for any harm caused by its product
places a tax on a steel producer’s pollution
legislates that it is illegal to discriminate on the basis of gender, ethnicity or sexual orientation
imposes a wage/price freeze
provides funding for a job search scheme
provides benefits for low income families
provides childcare funding to allow women to work
legislates to prevent misleading advertising
prevents large companies from merging

11. Range of Government Interventions
Method
Effect/ what it is
Best for:
Subsidy
Sales Tax
Income Tax
Regulations
Transfer Payments
Public Ownership/
Provision
Lowering the price to encourage the production and use of certain products. More resources are allocated to a good/service than would be provided by the free market.
Lowers the cost of production
Raises the price to discourage the production and use of certain products. Pay for some of the costs imposed on society as a result of the product being consumed
Increases the cost of production
Reduces Incomes
Reduces demand. Progressive taxation narrows the gap between rich and poor and reduces inequality of income
Limit or prohibit the production or consumption of certain products. Enforce the production or consumption of certain products
More direct effect than taxes or subsidies
Addressing income inequality in form of social welfare benefits and income support.
Redistribution of incomes from “rich to poor”
Situations where its not socially desirable for provision to be in private ownership. Providing G&S not sufficiently provided by the free market
Army, Police
Libraries, parks, Rubbish collection, Education