Government Failure 1.4.2

Question 1

What is government failure?

Answer 1

When a government cannot allocate resources effectively or efficiently, or it makes a market failure worse.

Question 2

What are the 4 causes of government failure?

Answer 2

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

Question 3

How does the government cause the distortion of price signals?

Answer 3

• occurs when a subsidy is given
• subsidies are given to inefficient firms
• firm becomes reliant on subsidy
• their revenue rises, thus their profit also
• they are kept in the market
• inefficient allocation of resources

Question 4

How does the government cause unintended consequences?

Answer 4

• when firms regulate a market
• aim is to reduce negative externality
• when a firm regulates too much costs of production rise
• this will force firms out of the market making the failure much worse

Question 5

How can government failure create a hidden market?

Answer 5

• govt can tax or regulate a market too much
• causes costs of production to rise
• inefficient firms are forced out of the market
• price of the good sky rockets
• people get around this by selling their own goods