Government failure Flashcards
Define government failure
When government intervention leads to an inefficient allocation of resources and a net welfare loss
Types of government failure
- Distortion of price signals
- Unintended consequences
- Excessive administration costs
- Information gaps
Evaluation of government failure
- 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
What is the distortion of price signals
Government actions which distort the operation of the price mechanism leading to a misallocation of resources
What can maximum price controls lead to
An excess demand or shortage
Long-term implications of max price controls for rental housing
- Reduction in both quality and quantity of rental housing available
- Leading to an increase in the number of homeless
What can minimum price controls lead to
An excess supply or surplus
Long-term implications of min price controls for agricultural products
- Problems of disposing food surpluses which are perishable and expensive to store
- May require government expenditure on surpluses which has an opportunity cost
Define law of unintended consequences
The actions government, producers or consumers will always have unintended effects
Unintended consequence of indirect taxes
- 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
Unintended consequence of subsidies
- 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
Unintended consequence of max price controls
- 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
Unintended consequence of min price controls
- 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
Unintended consequence of trade pollution permits
- 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
Unintended consequence of regulations
- 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
Define administration costs
The costs which arise in the monitoring and enforcing of government measures to correct market failure
Administration cost effects:
WAR
- Welfare benefits are difficult to calculate and monitor
* To make sure the right claimants receive the correct payments
Administration cost effects:
WAR
- 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
Administration cost effects:
WAR
- Regulations require constant monitoring to ensure they are adhered to
- E.g ensuring fishing boats do not exceed their fish quotas
Define government information gaps
The government having insufficient information to make rational economic decisions
How can information gaps lead to government failure
- 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
Examples of government information gaps
(RAG):
2.Reaction to inclusion of air travel
- 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
Examples of government information gaps
(RAG):
2.Allocation of fish quotas
- 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
Examples of government information gaps
(RAG):
1.Government setting of high income tax
- 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
