1.4.2: Government Failure

Question 1

When does government failure occur?

Answer 1

• When government intervention in the market leads to net welfare loss and a misallocation of resources.

Question 2

What are the main causes of government failure?

Answer 2

• Distortion of Price signals
• Unintended Consequences
• Excessive administration costs
• Information Gaps

Question 3

How does the distortion of price signals cause government failure?

Answer 3

• Distortion of price signals distort the free market mechanism.
• As result, they keep some companies in business when they are inefficient so the resources should be switched to somewhere else (subsidies) or make consumer pay too much for a good (taxes)

Question 4

What are the aims of the price mechanism?

Answer 4

• Aims to allocate resources to their best use and where consumer want and value them most highly

Question 5

How do minimum and maximum prices lead government failure (price signals)?

Answer 5

• Min and max prices lead to excess demand/ supply and make it difficult to allocate resources

Question 6

How do unintended consequences cause government failure?

Answer 6

• Consumers and producers may react to new policies in unexpected ways and so the policy doesn’t have the effect it should.
• This means that interventions cause effects which the government did not intend to happen

Question 7

Give an example of how unintended consequences cause government failure?

Answer 7

• The introduction of the buffer stock scheme CAP (Common Agricultural Policy) in the EU
• This was meant to steady price fluctuations but it lead to overproduction in the EU and a fall in agricultural prices in other parts of the world.
• This is as EU surpluses were disposed of at cheap prices outside Europe which wasn’t the intention.

Question 8

Statistics/ Facts on the CAP buffer stock scheme

Answer 8

• Price Stabilising: during periods of surplus, prices for grains like wheat and barley have been supported by EU purchases, helping maintain price levels compared to non-intervention scenarios
• Income Support: In 2020, around 38% of the average Eu farmer’s income came from direct payments, which include those linked to market support mechanisms
• Market Surpluses: In 2019, EU stock levels for certain grains reached over 20 million tons, showing the extent of overproduction and need for intervention

Question 9

How do excessive administration costs cause government failure?

Answer 9

• A lot of money that is allocated by the government is actually used up on basic administration costs.
• The social costs may be higher than the social benefits once administration costs are taken into account

Question 10

Examples of Excessive Administration Costs

Answer 10

• The NHS: a lot of money that is given to the NHS is actually spent on organisational administration rather than putting the money into medical care
• In 2023, the UK government allocated £160 billion to the NHS

Question 12

How does the distortion of price signals cause market failure?

Answer 12

• The distortion of price signals distort the the free market mechanism
• As a result, they keep some companies in business when they are inefficient so the resources should be switched to somewhere else (subisides) or make consumer pay too much for a good taxes