Government failure

Question 1

Define government failure

Answer 1

When government intervention leads to an inefficient allocation of resources and a net welfare loss

Question 2

Types of government failure

Answer 2

• Distortion of price signals
• Unintended consequences
• Excessive administration costs
• Information gaps

Question 3

Evaluation of government failure

Answer 3

• Government failure is often less serious than the market failure being solved
• Without intervention the problems associated with market failure are likely to be greater
• E.g high taxes and regulations on alcohol have reduced demand
• This has led to improved public health

Question 4

What is the distortion of price signals

Answer 4

Government actions which distort the operation of the price mechanism leading to a misallocation of resources

Question 5

What can maximum price controls lead to

Answer 5

An excess demand or shortage

Question 6

Long-term implications of max price controls for rental housing

Answer 6

• Reduction in both quality and quantity of rental housing available
• Leading to an increase in the number of homeless

Question 7

What can minimum price controls lead to

Answer 7

An excess supply or surplus

Question 8

Long-term implications of min price controls for agricultural products

Answer 8

• Problems of disposing food surpluses which are perishable and expensive to store
• May require government expenditure on surpluses which has an opportunity cost

Question 9

Define law of unintended consequences

Answer 9

The actions government, producers or consumers will always have unintended effects

Question 10

Unintended consequence of indirect taxes

Answer 10

• May lead to development of illegal markets
• E.g alcohol smuggling
• This leads to growth in organised crime and a loss of tax revenue for the government

Question 11

Unintended consequence of subsidies

Answer 11

• May lead to firms becoming dependent on subsidies and inefficient in production
• Difficult to withdraw subsidies once they are in place
• E.g grants to rail companies

Question 12

Unintended consequence of max price controls

Answer 12

• May lead to acute shortages of goods and services
• E.g max wage on highly skilled workers;
• Could lead to a shortage of specialised workers in the banking sector
• This could undermine economic growth

Question 13

Unintended consequence of min price controls

Answer 13

• May lead to surpluses of goods and services
• E.g a min wage for lowly skilled workers:
• Could lead to unemployment as labour becomes too expensive for firms to employ

Question 14

Unintended consequence of trade pollution permits

Answer 14

• May not reduce carbon emissions easily
• E.g large polluting firms may find it easier and cheaper to buy spare permits on the market
• Rather than investing in expensive equipment to reduce carbon emissions

Question 15

Unintended consequence of regulations

Answer 15

• May lead to regulatory capture
• This is where the regulator acts in the interest of firms rather than of consumers
• Even though the regulator is meant to protect consumers

Question 16

Define administration costs

Answer 16

The costs which arise in the monitoring and enforcing of government measures to correct market failure

Question 17

Administration cost effects:

WAR

Answer 17

• Welfare benefits are difficult to calculate and monitor

* To make sure the right claimants receive the correct payments

Question 18

Administration cost effects:

WAR

Answer 18

• Administration in terms of tax can be difficult and expensive for government
• E.g tax changes in a budget may take a year to implement

Question 19

Administration cost effects:

WAR

Answer 19

• Regulations require constant monitoring to ensure they are adhered to
• E.g ensuring fishing boats do not exceed their fish quotas

Question 20

Define government information gaps

Answer 20

The government having insufficient information to make rational economic decisions

Question 21

How can information gaps lead to government failure

Answer 21

• The government could lack sufficient knowledge of the effects of its intervention in a market
• This means the government could make non-rational decisions which lead to an inefficient allocation of resources and net welfare loss

Question 22

Examples of government information gaps
(RAG):
2.Reaction to inclusion of air travel

Answer 22

• Reactions from the world to the inclusion of air travel in the ETS has not been understood by EU governments
• EU has been forced to postpone the extension of the ETS
• This is due to threats of taxes in retaliation from other governments

Question 23

Examples of government information gaps
(RAG):
2.Allocation of fish quotas

Answer 23

• Allocation of fish quotas by EU governments appear to be set at a level too high
• This is because the depletion of fish stocks continues
• Fishing boats also throw back dead fish to avoid large fines and remain within their quotas

Question 24

Examples of government information gaps
(RAG):
1.Government setting of high income tax

Answer 24

• A government setting a high rate of income tax for top income earners may reduce the total tax take
• This is due to increased tax avoidance or evasion