Market Failure
Markets fail for a number of reasons:
- Externalities (social costs and social benefits)
- Monopolies
- Imperfect information
- Factor immobility
- Due to equity issues – where there is a disparity between resource allocation
Government Failure
This occurs when government interventions either increase the severity of market failure or cause a new failure to arise
This occurs when policies:
- Have damaging long term consequences
- Are ineffective
- Cause more problems than solve problems
Methods of Government Intervention
- Taxation
- Subsidies
- Buffer Stocks
- Pollution permits
- State provision
- Regulation
- Extending property rights
Extending Property Rights
Extending property rights is a method the government can use of internalizing the externality. The aim of extending property rights is to reduce the impact of the externality
Advantages
- The government doesn’t have to assess the value of property as the owners are in a better position to do this
- There will be a direct transfer of resources from the polluters to those who suffer – the firms who pollute will have to bear the negative effects
Disadvantages
- It can be difficult - governments may not have the ability to extend property rights especially overseas
- Extending property rights within a country can be difficult if the link between the pollution and the problem is unclear
- Its often difficult for the owner of the property to assess its value to them
Causes of Market Failure
Inadequate information, this may result from:
- Not doing a cost benefit analysis
- Insufficient information on long term costs / benefits
Conflicting objectives:
- Governments tend to think in the short term rather than the long term therefore fail to consider long term costs / benefits
- If governments control an industry they may be more concerned with their interests than those of the public
- If the policy interventions lead to negative consequences for consumers / producers e.g. higher income tax
Administration costs – these may be too high to reap the benefits of the intervention
Political self interest – politicians may do what is best for them thereby resulting in inefficient resource allocations
Regulatory Capture
Regulatory capture this is where a government regulatory agency who are meant to be acting in the public interest instead becomes dominated by the interests of the existing firms in the industry it is meant to be overseeing
Regulatory capture arises from the fact that the current firms have a stake in the outcomes of political decisions therefore ensuring they find a way to influence decision makers
Market Failure & Government Failure
The marginalist model of externalities is used to explain why externalities result in a misallocation of resources
This model looks at marginal social costs and social benefits to enable resource allocation to be efficient
By looking at marginal social costs and benefits the government can decide how to impact supply and demand for a specific product decreasing the marginal benefits
Government Policy & the Environment
Environmental change impacts economic behavior
There is increasing pressure on the government to consider environmental factors
The environment is often damaged by negative externalities caused by consumption and production
