1.3 - Government failure

Question 1

Government failure

Answer 1

This is when government intervention in markets or economic activities (public spending, taxes or regulations) leads to a net welfare loss (reduces overall economic welfare)

Question 2

What can cause government failure?

Answer 2

o distortion of price signals
o unintended consequences
o excessive administrative costs
o information gaps

Question 3

Distortion of price signals - government failure

Answer 3

• Government interventions, such as price controls or subsidies, can distort price signals in markets. - The signaling function of the price mechanism is artificially altered
• Distorted prices may not reflect true supply and demand conditions, leading to overproduction or underproduction of goods and misallocation of resources.

Question 4

Unintended consequences - government failure

Answer 4

Policies aimed at addressing one problem may inadvertently create new problems or unintended consequences.
These unintended consequences can result from imperfect understanding of complex markets and behavioural responses.

Question 5

Unintended consequences example

Answer 5

Producers and consumers aim to maximise their self interest

This often leads them to look for legal or illegal loop holes to bypass government intervention

This result creates unintended consequences such as the creation of illegal markets and/or illegal production/consumption

Question 6

Excessive administrative costs - government failure

Answer 6

• Government interventions often involve administrative costs related to implementation, monitoring, and enforcement.
• Excessive administrative costs can reduce the net benefits of a policy.
• The costs can sometimes be greater than the savings in social welfare

Question 7

Information gaps - government failure

Answer 7

• Government interventions may be based on incomplete or inaccurate information about market conditions or the behaviour of economic agents. (Decision makers do not have perfect information and Decision makers are subject to political pressure)
• This can lead to policies that do not effectively address market failures or achieve their intended goals.

Question 8

Government failure in various markets

Answer 8

1. Agricultural price supports
2. Subsidies in renewable energy
3. Rent controls

Question 9

Agricultural price supports - government failure

Answer 9

Government interventions in agriculture, such as price supports, can lead to overproduction of certain crops, surplus stockpiles, and waste.
These policies can result in government expenditures and inefficient resource allocation.

Question 10

Agricultural price supports - government failure - example

Answer 10

The European Union’s Common Agricultural Policy (CAP) has faced criticism for its support of excess production, leading to “butter mountains” and “wine lakes.”

Question 11

Subsidies in renewable energy - government intervention

Answer 11

While subsidies for renewable energy aim to reduce environmental harm, they can lead to inefficient resource allocation if not carefully managed.
Over-subsidisation can create market distortions and waste taxpayer funds.

Question 12

Subsidies in renewable energy - government failure - example

Answer 12

Spain’s generous solar energy subsidies led to an unsustainable boom in solar installations, which, when reduced, resulted in financial losses for investors.

Question 13

Rent controls - government failure

Answer 13

Rent control policies, designed to make housing affordable, can lead to housing shortages, deteriorating building conditions, and reduced investment in rental housing.

Question 14

Rent controls - government failure - example

Answer 14

In San Francisco, rent control policies have contributed to housing shortages and soaring housing costs for non-controlled properties.