1.4.2 - Government failure Flashcards
How does Government failure occur ?
● Government failure occurs when the government intervenes in a market to correct market failure, but the intervention results in a more inefficient allocation of resources from society’s point of view.
- This results in an even greater welfare loss to society.
What are the causes of Government failure ?
o distortion of price signals
o unintended consequences
o excessive administrative costs
o information gaps
Video link
Blurt everything you know about distortion of price signals.
Signalling- One mechanism of price is signalling which, signals to producers where resources need to be allocated.
- Government intervention can caused the signaling function of the price mechanism to be artificially altered and therefore it can not act freely e.g
- Subsides : Firms can become become reliant on government subsidies rather than trying to become more productively efficient in order to become more competitive in the market. If it was left to the free market, inefficient firms wouldn’t survive in the market. However, government intervention has distorted these price signals as now subsidised firms have a higher level of revenue than if they weren’t subsided. This means that they achieve profit levels high enough to remain in the market. If the government hadn’t intervened then the firms would not be breaking even and therefore would be forced out of the market. Overall, this leads to an inefficient allocation of resources as a result of the price mechanism not being able to act freely.
- ## Maximum prices: Lead to excess demand, but they also lower the price of merit good, a decrease in price signals to producers to supply less of that good, which is opposes the whole point of the minimum price anyways. (Making merit goods more affordable) so if firms and producers stop supplying these goods as a result of the signalling price mechnaism there will be a very inefficient allocation of resources as producers are aren’t supplying more merit goods to eradicte the excess demand.eval point - depends on how much excess demand there is.
-gov may intervene to subsidies merit good markets. - It depends on whether and how far the
maximum price is below the market
equilibrium price. - It depends on the PED for energy.
- Comment on the impact on producers –
producer behaviour e.g. may move up to the
price cap, reduce investment - Minimum pices: Lead to excess supply, but they also increase the price of demerit goods which signals to firms to supply more however there is already an excess of supply in the market so supplying more will lead to even more excess supply. Which leads to market faliure as when firms supply more of these demerit goods (e.g minimum price on alcohol) they will be wasting factors of production to to supply theses good/services when they aren’t being used up/bought up. However this again depends on whether or not the good is demand inelastic or elastic.
- Additoinally governmnent can intervene to buy up the excess supply
Blurt everything you know about unintended consequences.
- Minimum prices: Lead to excess demand, which is good as it helps to reduce the consumption of demerit goods however this may lead to unintended consequences such as the formation of black markets as firms are unable to make a profit at the prices which price floor is set at. this may lead to higher levels of illegal activity which can lead to higher crime rates and loss of tax revenue for governments.
- State provision of public goods :
- State provision of public goods (e.g healthcare) may lead to unintended consequences such as the decrease in the quality and quantity of these goods, or an decrease productivity/efficiency of that good. This is because without a drive for profit, there isn’t much incentive to make services as efficient as possible. As a result the economic **incentives for productivity/efficiency **could be eroded.
P.S - Unintended consequences can also be positive.
Blurt everything you know about Excessive administration costs.
- Administrative costs are the costs that are related to running the business that don’t relate to the products or sales. e.g office supplies, professional fees, executive salaries and employee salaries.
- Trade Pollution permit scheme and Regulation : The cost of policing the pollution levels of all the firms are more than the social benefits. This creates a huge opportunity cost as instead of trying to reduce CO2 emissions by these permits the government can instead use the money that they spend on policing firms CO2 emission and invest it in subsidising more electric cars, or wind farms, solar panels or invest it in research and development to find new ways of reducing CO2 emissions for firms this will lower administrative costs in the long run and have a more social benefits in the long run.
Blurt everything you know about Information gaps.
- This applies to all types of gov intervention.
- The gov don’t have Perfect information and they are subject to political pressure when making decisions on how to intervene to correct market failure.
- As a result this may lead to them :
● Indirect taxes : Setting taxes too high so may lead to more inequality as it impacts those on lower incomes more than high-income earners. Although everyone pays the same price for the same product, every income is different and, therefore, you may end up paying more as a percentage of your income than a higher income earner.
● Subsides :
o Subsiding a market more than they need to which creates a huge opportunity cost as money can be invested in a different market which also needs subsidising.
o Not subsidizing a market enough which will affect the rate that the social optimum is reached.
● Maximum prices :
o Setting maximum prices to high which will to more excess demand.
● Minimum prices:
o Setting minimum prices to low which can result to minimum prices becoming ineffective.
- Trade pollution permits:
● State provisions of public goods:
o Not providing enough public goods which may lead to more inequality to society as well as decreasing the rate at which we can reach the social optimum.
o They may be providing to many public goods which will result in decreased competition for these goods and so there will be less incentivised to be productive/efficient as well as decreasing the quality of these goods.
● Provision of information:
o Not providing enough information may lead to the continual consumption of demerit goods.
o Too much information provision may lead to a cut in spending in areas that investment by the government is needed.
● Regulation:
o Regulating a market to much which can lead to the formation of black markets as well as a huge opportunity cost as there will be excessive administrative cost related to regulation.
o Not regulating a market enough which won’t fix the issue associated with what they are regulating.
