Markets to Correct Problems Essay

Should governments always intervene in the markets to correct problems when free markets fail to allocate resources efficiently? [1 5] What Is market failure? Market failure Is defined as the situation where the free market fails to achieve allocation efficiency – the market fails to achieve an outcome that maximizes society welfare. Government intervention during market failure may in certain cases be Justified, but in other cases unjustified.

This essay intends to discuss if government intervention in markets that fail is Justified and effective, by dressing and focusing on the economic problem of externalities, demented goods, and the lack of provision of public goods. Governments can utilities various methods to address externalities and demerit goods. Externalities are third party spillover effects, and can be both positive and negative, and can come from consumption or production sides. Demerit goods are goods that either cause negative externalities, or are goods that governments deem unacceptable for their citizens, for instance smoking and gambling.

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In the case of negative externalities and demerit goods, when goods are over-consumed as their original social costs exceed the marginal social benefit, the government may adapt the use of an output tax to prevent the over-consumption of the good. [Insert a diagram on output tax showing how this policy cures the problem] Imposing a tax per unit that is equal to the MACE shifts the MAC to the left. The new private equilibrium now coincides with the new social equilibrium Sq where MS = MASC..

Allocation efficiency Is achieved as the output has been reduced to the social optimal level and therefore government Intervention Is Justified. Alternatively, the government may also impose an output quota which is defined as he limit for the quantity that the industry can legally produce, therefore effectively reducing the over-consumption of the good generating either negative externalities or demerit goods. [Insert a diagram for output quota showing how this policy cures the problem] The original equilibrium is determined by the intersection of MASC. and MS.

When the government imposes a quota, the new equilibrium price increased while output falls. Therefore, the quota effectively increases the equilibrium price and decreases the equilibrium quantity of the good. In the case of positive externalities and merit goods, the government may choose to adopt the policy of subsidies to effectively reduce the extent of under-consumption of socially desirable outcome. (Insert diagram on subsidies showing how this policy cures the problem] Giving producers a per unit subsidy that is equal to MOB lowers their production costs and shifts the MAC to the right.

The initial social equilibrium of Sq where MS = MASC. now coincides with the new private equilibrium. Allocation efficiency is now achieved as output is now raised to the socially optimal level. Alternatively, the government may also provide for the good completely free to the society, so as to reduce the extent of under-consumption of the good that brings about positive externalities or merit goods. Also, in the case of public goods, there is missing market and usually governments have to provide the good for society.

Public goods are goods that are non rival and non clubbable, which means that they cannot be “used up” when someone consumes them, such that there is less of the DOD for others, and which means that no one can be excluded from the consumption of the good, respectively. For instance, defended and street lighting are doth public goods because they are non rival and non clubbable goods. These two conditions of non-rivalry and non-calculability imply that the good has MAC = O, and also that there will be free riders, and therefore profit oriented companies simply will not produce the good as they are assumed to be profit driven. Insert diagram on free provision of goods showing how this policy cures the problems (plural)] For free provision, the social outcome where output is at Sq, is when MS = MASC.. En the output is subsidized, MASC. shifts to the right, where the socially optimal output of Sq is achieved. Therefore the effective price of the good is now zero and the entire cost of the good generating positive externalities or merit goods is now absolutely borne by the government.

However, although government intervention in the market may seemingly be beneficial in helping to shift prices and output to the socially desirable outcomes, they may not always be Justified, as there are limitations to it as well. In the case of demerit goods and externalities, high implementation, enforcement and mentoring costs may be incurred by the government in fulfilling its role as an interventionist ND thus the total administrative costs may exceed the benefits from implementing such measures, leading to an overall decline in society welfare.

Taxing the public may also be politically unpopular and therefore hinder governments from implementing such measures by placing political interest over economic ones. Moreover, in the case of merit goods and positive externalities, using subsidies to resolve the problems posed may be economically costly and full provision may lead to over-production and over-consumption beyond the socially optimal level and Hereford lead to allocation inefficiency as well, therefore proving that government intervention is not Justifies and not effective to a large extent.

Hence, in the final analysis, whilst government intervention in the case, where market failure arises, may be beneficial to a limited extent in helping society to maximize its short term benefits enjoyed by society as seen in the limitation of using subsidies, quotas, taxes and free provision. Therefore, markets should be rid of government intervention to a maximal extent, because it is only effective in the short run and to minimal extents and therefore is unjustified as a whole.