State/Direct Provision for solving market failure

• State provision


  The direct provision of goods and services by the government free at the point of consumption
• State provision is an extreme policy to solve market failure because the government is taking over the market completely, allocating all resources towards a given good or service and providing that good or service free at the point of consumption
• When using state provision to solve market failure

  • You need more than just under-consumption and under-production of a good/service
  • There also needs to be inequity (unfairness) in the free market provision of key merit goods like healthcare and education, where a price is charged and some consumers are excluded
• Examples of merit goods where state provision can be justified


  • Healthcare
  • Education
• How state provision works

  1. Government assumes it knows the full social cost and social benefit, and can determine the socially optimal level of output

  2. Government allocates a fixed budget to the market each year, making the supply curve vertical and perfectly price inelastic

  3. Price is set at zero, providing universal access
• When price is zero with state provision

  There is excess demand
• Issues with rationing excess demand under state provision

  • Rationing based on severity of condition is subjective and leads to some people living in pain
  • Rationing by lottery/catchment area is inefficient
  • Allowing long queues and waiting lists leads to lower quality provision
• Consumers don't pay a price, but pay in other ways like pain, poor quality, or having to go to the private sector
• Issues with the cost of state provision

  • Huge sums of taxpayer money required, leading to higher taxes, cuts to other spending, or debt
  • Government may not have perfect information to determine the socially optimal level, risking government failure
  • State-run organisations tend to be inefficient without profit motive, wasting resources
• State provision is a highly interesting policy that requires careful debate and consideration of the specific market context