Economics of Market Failure :: Government Intervention

Market failure has become an increasingly important topic for students. In simple terms, market failure occurs when markets do not bring about economic efficiency. There is a clear economic case for government intervention in markets where some form of market failure is taking place. Government can justify this by saying that intervention is in the public interest. Government intervention occurs when markets are not working optimally i.e. there is a Pareto sub-optimal allocation of resources in a market/industry. In simple terms, the market may not always allocate scarce resources efficiently in a way that achieves the highest total social welfare. There are plenty of reasons why the normal operation of market forces may not lead to economic efficiency. Public Goods Public Goods not provided by the free market because of their two main characteristics  · Non-excludabilitywhere it is not possible to provide a good or service to one person without it thereby being available for others to enjoy  · Non-rivalrywhere the consumption of a good or service by one person will not prevent others from enjoying it Examples: Streetlighting / Lighthouse Protection, Police services, Air defense systems, Roads / motorways, Terrestrial television, Flood defense systems, Public parks & beaches Because of their nature the private sector is unlikely to be willing and able to provide public goods. The government therefore provides them for collective consumption and finances them through general taxation. Merit Goods Merit Goods are those goods and services that the government feels that people left to themselves will under-consume and which therefore ought to be subsidized or provided free at the point of use. Both the public and private sector of the economy can provide merit goods & services. Consumption of merit goods is thought to generate positive externality effects where the social benefit from consumption exceeds the private benefit. Examples:Health services, Education, Work Training, Public Libraries, Citizen's Advice, Innoculations Monopoly Few modern markets meet the stringent conditions required for a perfectly competitive market. The existence of monopoly power is often thought to create the potential for market failure and a need for intervention to correct for some of the welfare consequences of monopoly power. The classical economic case against monopoly is that  · Price is higher and output is lower under monopoly than in a competitive market  · This causes a net economic welfare loss of both consumer and producer surplus  · Price> marginal cost - leading to allocative inefficiency and a pareto sub-optimal equilibrium. See also the study page on economic efficiency  · Rent seeking behaviour by the monopolist might add to the standard