Government failure

Question 1

Government failure

Answer 1

• It occurs when the governments intervention in the market makes economic welfare worse rather than better
• Resources are allocated less efficiently than would have been the case had the governments not intervened

Question 2

Causes

Answer 2

• Inadequate information
• Conflicting objectives
• Administrative costs

Question 3

Inadequate information

Answer 3

• The government like other decision makers does not enjoy perfect knowledge
• As a result it may make decisions that turn out to misallocate resources

Question 4

Conflicting objectives

Answer 4

• The government often faces conflicting objectives
• E.g. keeping down rates of tax and increasing spending on the health service
• It will fail if the welfare gain from the sacrificed alternative exceeds the welfare gain from chosen option
• Taxes may be kept down to win an election, but the resources left in the hands of the electorate may not be spent as effectively as when spent by government

Question 5

Administrative costs

Answer 5

• The costs of correcting market failure may exceed the benefit from its attempted eradication
• E.g. the cost of maintaining the prohibition pf certain drugs may exceed the external costs of consumption
• A well intentioned move may make matters worse for society

Question 6

Consequences

Answer 6

• Market distortions
  > Government action to correct one market failure may create a more serious failure by distorting the market
• Economic welfare worsens
  > Scarce resources may be wasted because they are not allocated to the use that would maximise the net social benefit