government intervention

• Market failure


  The market does not always allocate resources efficiently
• Government intervention to correct market failure

  1. Indirect taxes

  2. Subsidies

  3. Maximum and minimum prices

  4. Trade pollution permits

  5. State provision of public goods

  6. Provision of information

  7. Government regulation
• Indirect taxes


  Used to correct market failure by reducing supply and quantity demand of a product that is being over produced/consumed
• Indirect taxes


  • Taxes on cigarettes to discourage smoking (negative externality) and raise revenue for healthcare programs
• Firms respond to indirect taxes

  Producing less because their costs of production have now risen due to tax
• Level of tax


  Needs to be set so that negative externalities are eliminated and MSC = MSB
• Introducing a tax


  Brings the market to its social optimum where social welfare is maximised
• Subsidies


  Financial assistance provided by the government to encourage production or consumption of certain goods and services
• Introducing a subsidy


  Brings the market to its social optimum where social welfare is maximised by bringing the private benefit up to the point where MPB = MSB
• Maximum prices (price ceilings)

  Government-imposed limits on the price of a good or service, set below the equilibrium price to protect consumers from high prices
• Maximum prices


  Lead to shortages (excess demand) for the product, leaving some consumers worse off and may lead to black markets
• Minimum prices (price floors)

  Government-imposed limits on the price of a good or service, set above the equilibrium price to support producers and ensure they receive a fair income
• Public goods


  Goods that are non-rival and non-excludable, so will either not be provided by the market or only provided in small quantities, resulting in market failure
• Government provision of public goods

  1. Use tax revenue to provide public goods so that they are free or largely free (e.g. national defence, street lights, public parks)

  2. Can come directly from the government or be purchased from the private sector and provided to the public for free
• Regulation


  Government rules and standards to ensure market participants follow specific guidelines, usually backed by legislation and enforced by authority
• Tradable pollution permits


  Governments allocate a limited number of permits to firms allowing them to emit a certain amount of pollution, which can be bought and sold
• Provision of information


  Governments provide information to consumers to ensure informed decision making, helping improve market efficiency and protecting consumers
• Provision of information


  • Food labelling regulations
  • Advertising campaigns about not smoking or drink driving
  • Cigarette packaging warnings