Government failure could worsen the market failure already present or a new failure might occur.
Government failure leads to a net welfare loss to society.
Causes of government failure:
Distortion of price signals
Unintended consequences
Excessive administrative costs
Information gaps
Unintended consequences
With government policies, consumers react in unexpected ways. A policy could be undermined, which could make government policies expensive to implement, since it is harder to achieve their original goals.
Distortion of price signals
Government subsidies could distort price signals by distorting the free market mechanism.
Distortion of price signals
A free market economist would argue that this could lead to government failure. There could be an inefficient allocation of resources because the market mechanism is not able to act freely.
Distortion of price signals
For example, the government might end up subsidising an industry which is failing or has few prospects.
Excessive administrative costs
The social benefits of a policy might not be worth the financial cost of administering the policy.
Information gaps
Some policies might be decided without perfect information. This might require a full cost-benefit analysis, and it could be time-consuming and expensive.
Information gaps
However, it is impractical for governments to gain every bit of information they need, so assumptions are made.
