1. Government Intervention in the Market
A2 Economics
Government Intervention in the Market

2. 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.

3. Starter Define market failure.
How many causes of market failure can you think of?

4. 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)

5. 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.

6. Government Intervention Methods
Government Legislation and Regulation
Direct provision of goods/services
Fiscal policy
Improving information

7. Government Failure Causes
Political self-interest
Imperfect information
Unintended consequences
Regulatory capture

8. 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’.

9. 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

10. 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.

11. 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

12. 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.

13. 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

14. Government Intervention to Correct Environmental Market Failure - Problems
In groups decide reasons as to why using an environmental tax would be problematic.

15. 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.

16. 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.

17. 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.

18. Plenary
How could these government intervention methods result in government failure?