Government failure

Question 1

Government failure-

Answer 1

When government interventions to correct one or more market failures leads to a greater net social welfare loss - failure can also occur if a policy fails to create enough of an incentive to change the behaviour of different agents to meet the aims of a policy

Question 2

Causes of government failure

Answer 2

Inaccurate information about the true costs and benefits of a policy
When information is distorted by special interest groups
Principal-agent problems
Public choice theory - states state officials are driven by self-interest rather than public interest
The government’s responsible for setting up regulators to control industry’s behaviour.

Question 3

Principal agent problems

Answer 3

When the interests of the government and people implementing the policy aren’t aligned
E.g. shareholders look for short term value, but CEOs in a company look for long term value, and they both have different self-interests

Question 4

Examples of government failure

Answer 4

Policy leads to greater inequality(basic income tax rate fell from 33% to 22% for workers to keep more income, but this favours the richest households more, so has led to an increase in income inequality)

Unintended consequences(criticism of young people’s mental health in lockdowns) - the price of travel permits needed by EU and US citizens to enter the UK is to rise from £10 to £16, to reduce the reliance of the migration and borders system on taxpayer funding.
Additionally, while the New York congestion pricing scheme intends to cut traffic and help fund $15bn to improve local mass transit/transportation, this $4.50-$14.4} toll to enter the congestion zone may be difficult for all consumers to pay, extra cost for consumers).
Bus passengers face a new £3 cap, money raised supports travel in rural communities and towns, but this can also make consumers more reluctant to use the bus due to higher costs.
An increasing clawback tax has made drugmakers frustrated with the NHS, as pharmaceutical companies are warning investment may be at risk.
High enforcement costs
Regulatory capture(regulators start acting in the interests of the company, due to impartial information, rather than in consumer interests e.g. after the financial crisis of 2008, there was financial regulatory capture in the bank8ng sector, with regulators becoming so comfortable that this resulted in incomplete supervision of rules and regulations in banks)
Failure to rigorously test a policy
Conflicts with other policy aims(e.g.taxes to reduce inequality could lead to higher rates of inflation)

Question 5

Government objectives for industries

Answer 5

Efficiency
Equity

Question 6

The law of unintended consequences

Answer 6

The idea an action can have unanticipated outcomes, both positive and negative

Question 7

Example of unintended consequences

Answer 7

A carbon tax may lead to a reduction in emissions, but it could also lead to companies offshoring their operations to countries without a carbon tax or passing the cost of tax onto consumers.

Question 8

Distortion of prices

Answer 8

When the government intervenes in markets, it can cause a distortion of price signals by artificially changing the price of a good or service.

Question 9

Example of price distortion

Answer 9

To ensure farmers a minimum income, the government can provide subsidies for domestic agricultural products. This will lower the market price, leading to an increase in demand and consumption , but can also cause a misallocation of resources and an inefficient use of productive capacity.
Another example is when the government imposes a price floor, such as a minimum wage, which will cause unemployment, as firms will be reluctant to hire workers at the higher wage e.g. Biden’s administration couldn’t overcome opposition to raising the federal minimum wage.

Question 10

Price mechanism functions

Answer 10

1) Signalling functions(to producers and suppliers, so the right quantity of a good is supplied at the price a consumer’s willing to pay).
2) Allocative function(allocation of scarce resources depends on the price mechanism)
3) Incentive function(the price mechanism incentivises the entrepreneurs creating businesses to produce goods and services).
4) Rationing function(when demand outweighs supply)

Question 11

Examples of the price mechanism rationing

Answer 11

Plane tickets might rise as seats are sold, because spaces are running out. This is a disinentive to some donsumers to purchase the tickets, which rations the tickets.

Question 12

Government policy and information failure

Answer 12

Information failure can lead to the implementation of government policies not based on accurate information about the social costs and benefits of one or more policies, with these policies designed to solve one problem, but end up creating unintended consequences.

Question 13

Consequences of government policy and information failure

Answer 13

It can lead to a lack of trust in the government and the policies it implements- in 2024, problems with the NHS and the ‘cost of living crisis’ mean in Britain, a record high of 45% now say they almost never trust governments of any party to place the needs of the nation above the interests of their own political party.
It can lead to inefficient allocation of resources(net social welfare loss).

Question 14

Conflicting objectives and government failure

Answer 14

Government failure can be caused by policies that lead to a conflict of objectives(
problem of multiple goals).
When the government pursues multiple goals through its policies, it can often end up with conflicting objectives.

Question 15

Example of conflicting objectives and government failure

Answer 15

Environmental policy- where the goal of protecting the environment can conflict with the goal of economic growth and keeping prices low.
Labour reform(2024-25) means NHS bosses are given fewer targets to focus on issues that matter most to patients(e.g. improved access to GPs and dentists, and cutting waiting times for operations, and urgent and emergency care: tendency to create too many targets in healthcare, with an excessive focus on hitting these meaning patients could be disastrously neglected themselves.
Joe Biden’s $1.9 trillion American Rescue Plan in 2021- which provided direct stimulus payments to households - played a critical role in raising the cost of everyday essentials such as eggs and rent.
Donald Trump’s plans for higher tariffs,
lower taxes and curbs on immigration risk reviving inflation and preventing the Federal Reserve from cutting interest rates - would cause negative shocks to supply of US goods

Question 16

Economic goals of government(and examples of conflicting objectives)

Answer 16

Economic growth(can’t achieve economic growth without attracting rich foreigners to the country)
To reduce unemployment(e.g. if the British Government had given Tata Steel more money to switch to electricity(subsidy),more people would have stayed in employment)
To maintain price stability
To achieve equity

Question 17

What is regulatory failure/capture?

Answer 17

A type of government failure that occurs when regulation fails to achieve its intended purpose e.g. hundreds of sites with permission for high rise housing are standing empty, because the new Building Safety Regulator is struggling to process them, eight years after the tragic Grenfell Tower fire.q

Question 18

Reasons for regulatory failure/capture

Answer 18

The regulators may not have the information or resources they need to effectively regulate.
The regulators may be captured by the industry they’re regulating, leading to weak or ineffective regulations(e.g. teachers may be biased if chosen to regulate OFSTED - conflict of interest).
Finally, regulators may be subject to political pressure, which can result in regulations that are not in the public interest.
Constantly changing rules which businesses struggle to keep with
Mission creep - expanding a project/intervention beyond its original scope/focus/goals
Ministers are risk averse

Question 19

Consequences of regulatory failure

Answer 19

Regulatory failure can have serious consequences, including a loss of public trust in government and the failure of regulation to achieve its intended goals.

Question 20

Examples of government failure due to government interventions

Answer 20

Government introduces an import tariff on steel to protect profits and jobs in domestic steel manufacturing firms - Tariff increases costs for car and construction companies
Smoking ban is introduced in all public places including pubs and restaurants-
Increase in litter/emissions from outdoor patio heaters
Government introduces landfill tax(on weight of waste sent to registered landfill sites)- Rise in illegal fly-tipping of waste
Government announces £10bn project to widen the M25 as a way of reducing traffic congestion -
The majority of vehicles are running on fossil fuels,induced demand - increased supply causes more vehicles

Question 21

When does regulatory capture happen?

Answer 21

When regulatory agencies become sympathetic to the commercial interests of the regulated industry. This can be the result of lobbying(political pressure) by corporations, for policy outcomes to suit their commercial/financial interests.

Question 22

Example of UK government intervention

Answer 22

A UK steel safeguard measure - a quota(limit) on imports of certain steel products and a 25% tariff on imports above the quota, to protect the UK domestic steel industry from a surge in imports.
Worries the UK Steel industry doesn’t produce sufficient quantity to meet existing demand(they’ll see a rise in costs).
Steel is an intensively traded product - a glut on steel on global markets has depressed its value. Steel industries are often heavily subsidised by national governments - production levels exceed what the market would otherwise dictate.

Question 23

Examples of possible government failure from imposing quotas and tariffs on imported steel into the UK

Answer 23

1) Tariffs and quotas lead to higher costs for downstream users of steel. It might lead to higher construction costs, which makes new housing less affordable or e-vehicles more expensive(unintended consequences).
2) Risk of other countries imposing retaliatory trade barriers - this can cost jobs in other export industries

Question 24

How tariffs impact consumer surplus

Answer 24

A tariff would increase the price, decrease the quantity and reduce the consumer surplus, but increase the producer surplus

Question 25

Example of government intervention that would correct market failure

Answer 25

American consumers would benefit if Trump subsidised EV manufacturers(cheaper prices)- corrects market failure, as well as taxing diesel and petrol.

Question 26

Examples of possible government failure from imposing rent controls in Scotland

Answer 26

The Scottish government introduced a rent increase cap in rented housing and a pause on some evictions(the process by which a landlord can legally remove a tenant from a rental property) in 2022.
The rent cap increase was set at 0% effectively freezing rents. The measures were intended to protect tenants during the cost of living crisis.
Critics of the policy have argued freezing rents risks hitting new supply of rented property, especially in the private sector which might worsen affordability and availability problems over the longer term. It might negatively impact on other Scottish government objectives around net zero and energy efficiency.

Question 27

Example of government intervention to correct market failure

Answer 27

By 2030, Keir Starmer has promised 1.5 million new houses, due to a shortage of rented housing as a result of rent prices

Question 28

Examples of possible government failure from imposing rent controls in Scotland

Answer 28

1) Possible exit of landlords from the market due to sub-normal profits. This reduces supply and leads to a greater shortage of rental properties - increasing the risk of shadow markets(an illegal market where economic activity isn’t recorded and the authorities know nothing) operating(deepens existing market failure).
2) Fall in the quality of stock of rented housing, as landlords find ways to cut costs. This can lead to negative externalities, such as tenants experiencing worsening health and limits process in reducing carbon emissions(policy conflict).

Question 29

Government intervention for unintended consequences of capped rent

Answer 29

Subsidising the landlords means they can stay and rent houses, but this is at the expense of the taxpayer.
If tenants can’t afford to pay rent, the government can help by subsidising them.

Question 30

Regulating and taxing energy drinks

Answer 30

Young people in the UK are the biggest consumers of high-caffeine energy drinks in Europe for their age- leading brands of energy drink include Red Bull, Monster, Relentless and Rockstar. In the UK, shops and supermarkets have the option to ban energy drinks that are high in caffeine and not recommended for children. It is not government intervention yet though.
Some are campaigning for a ban on the retail sale of these drinks to all under 16s. Poland has recently brought in a law banning sales to people aged 18 and under.

Question 31

Capped rent impact

Answer 31

Unintended consequences(chasing away some of the housing and forcing the rent prices even higher)- but massively increased consumer surplus

Question 32

Examples of possible government failure from banning high-caffeine drinks to people under the age of 16

Answer 32

1) Black Market and Illegal sales: Prohibiting the sale of high-caffeine drinks to young people may create a black market where these beverages are sold at high prices.
2) Enforcement costs: Enforcing a ban on high-caffeine drinks can be expensive. Failure to impose the ban would make it less effective, and a ban doesn’t address the underlying causes of rising consumption, such as inadequate nutrition or parental guidance.

Question 33

Possible causes of government failure from imposing a minimum retail price for high caffeine drinks

Answer 33

1) Low PED and low effectiveness: The policy might be ineffective if demand for these drinks is price inelastic. It would take a high minimum price to have a substantial effect, which might have regressive impacts on lower-income families.
2) Substitution effects: Imposing a minimum retail price on high caffeine drinks may lead to unintended substitution effects. Young people might shift their consumption to potentially unhealthy alternatives, such as energy drinks that contain additives and artificial sweeteners.

Question 34

High caffeine drink - higher prices impact on equity

Answer 34

High-caffeine drinks are largely consumed by low-income consumers, but charging more for these products is more difficult for people on lower incomes, meaning you’re failing to reach equity.