Market Failure Flashcards
What are the two microeconomic problems that require government intervention?
- Inefficiency in resource allocation: due to allocative and productive inefficiency, governments need to get markets to produce at the social optimum level.
- Inequitable distribution of income: distribution of output may not be equitable or fair.
What is market failure?
The failure of the free market to achieve an efficient allocation of resources that maximises the society’s welfare.
Allocative efficiency:
- Society producing and consuming a combination of goods and services that maximises its welfare, when goods and services are produced in the right quantities.
- 1 point on PPC curve
- Consumer and producer surplus is maximised
- Price = Marginal benefit
- Marginal social benefit = Marginal social cost
Productive efficiency:
- All resources fully and efficiently utilised and the cost of producing any given level of output is minimised.
- Any point on the PPC
- Any point on LRAC (firm’s POV)
- Produce at MES (society’s POV)
What are the reasons for market failure?
- Externalities
- Information failure
- Zero provision of public goods
- Market dominance
- Immobility of factors of production
What are externalities?
Some costs or benefits associated with the production or consumption of a good spills over to third parties (parties other than the immediate seller and buyer).
Terminologies for externalities:
MPC: costs to producers of producing one more unit of a good
MEC: costs on third parties when one more unit of good is produced
MSC: costs to society of producing one more unit of a good (MPC+MEC)
MPB: benefits to consumers of producing one more unit of a good
MEB: benefits on third parties when one more unit of a good is produced
MSB: benefits to society when one more unit of a good is produced (MPB+MEB)
What are the types of externalities?
- Negative externalities from production
- Negative externalities from consumption
- Positive externalities from production
- Positive externalities from consumption
What are negative externalities from production?
External costs imposed on third parties from the production of a good or service.
Explain negative externalities from production:
Sellers, in pursuit of self interest, will only consider their own private costs of production, ignoring the external costs. When MEC>0, there is a divergence between MPC and MSC, as MSC>MPC. Free market equilibrium output is where MPC=MPB, however, at this output level, MSC>MSB since MSB=MPB. Welfare would increase if fewer goods are produced, meaning free market equilibrium output is allocatively inefficient and results in overproduction, resulting in deadweight loss.
What are negative externalities from consumption?
External costs imposed on third parties from the consumption of a good or service.
Explain negative externalities from consumption:
Buyers, in pursuit of self interest, will only consider their own private costs of consumption, ignoring the external costs. When MEB<0, there is a divergence between MPB and MSB, as MPB>MSB. Free market equilibrium output is where MPC=MPB, however, at this output level, MSC>MSB since MSB=MPB. Welfare would increase if fewer goods are produced, meaning free market equilibrium output is allocatively inefficient and results in overproduction, resulting in deadweight loss.
What are positive externalities from production?
External benefits enjoyed by third parties from the production of a good or service
Explain positive externalities of production:
Sellers, in pursuit of self interest, will only consider their own private costs of production, ignoring the external benefits. When MEC<0, there is a divergence between MPC and MSC, as MPC>MSC. Free market equilibrium output is where MPC=MPB, however, at this output level, MSB>MSC since MSB=MPB. Welfare would increase if more goods are produced, meaning free market equilibrium output is allocatively inefficient and results in underproduction, resulting in deadweight loss.
What are positive externalities of consumption?
External benefits enjoyed by third parties from the consumption of a good or service.
Explain positive externalities of consumption:
Buyers, in pursuit of self interest, will only consider their own private costs of consumption, ignoring the external benefits. When MEB>0, there is a divergence between MPB and MSB, as MSB>MPB. Free market equilibrium output is where MPC=MPB, however, at this output level, MSB>MSC since MSB=MPB. Welfare would increase if more goods are produced, meaning free market equilibrium output is allocatively inefficient and results in underproduction, resulting in deadweight loss.
What is information failure?
People having inaccurate, incomplete, uncertain or misunderstood data and hence make potentially suboptimal choices about their behaviour, resulting in over or underconsumption of a good or service.
What are the types of information failure?
- Imperfect information
2. Asymmetric information
What is imperfect information?
Individuals not knowing the full private costs or benefits of consuming a good.
How does imperfect information result in over-allocation of resources?
Imperfect information results in people being unaware if the true private costs arising from consuming a good, thus overestimating their own private benefits and over-value the good. Demand for the good under imperfect information is higher than that under perfect information. Good will be over-consumed and the market fails to achieve allocative efficiency as too many resources are diverted to the production and consumption, which will result in a welfare loss.
Supplier induced demand through advertisements can increase demand through influencing tastes and preferences.
How does imperfect information result in under-allocation of resources?
Imperfect information results in people being unaware of the true private benefits arising from consuming a good, thus undervaluing their own private benefits and under-value the good. Demand for the good under imperfect information is lower than that under perfect information. Good will be under-consumed and the market fails to achieve allocative efficiency as too few resources are diverted to the production and consumption, which will result in a welfare loss.
What is asymmetric information?
One party involved in a trade having more or better information compared to another when making decisions and transactions.
What are the consequences of asymmetric information?
- Adverse selection
2. Moral hazard
How does asymmetric information result in adverse selection?
When seller knows more about the good than consumer, they will try to conceal information in pursuit of profits. Buyer’s will hence offer a lower price as they cannot tell good quality goods from bad quality ones. This low price discourages sellers of peaches to offer their goods for sale, giving rise to a market for lemons. The market ends up adversely selecting against the peaches.
When buyers’ know more about themselves than sellers, they conceal information in pursuit of utility. Sellers hence charge higher prices, discouraging individuals who don’t need the good as much from buying the good. The sellers are left with an adverse pool of buyers.
Good products and consumers are under-represented while bad products and consumers are over-represented and could even lead to a missing market.
What is moral hazard?
A situation in which economic agents take greater risks than they normally would, because the costs that result from their riskier behaviours would not be solely borne by themselves.
How does asymmetric information result in moral hazard?
Insurance companies lack information about whether and how the insured would change their behaviour when they are protected by the insurance. The insured will have the tendency to take less care to prevent that loss when they are protected from the harmful consequences through the insurance. The riskier behaviour increases the social cost and use of scarce resources, leading to misallocation of resources.
What are the defining features of public goods?
- Non-rivalry in consumption: consumption of the good by one person does not reduce the amount or benefits available to others.
- Non-excludability: impossible or very costly to exclude non-payers from consuming the good once it is provided.
- Non-rejectability: good cannot be rejected by beneficiaries once the good is provided.
Why are public goods not provided by the free market?
Good is non-excludable, thus no one has the incentive to pay for it resulting in the free-rider problem. Revenue cannot be generated. Additionally, to achieve an allocatively efficient provision of a public good, price should equal to MC, but since MC of providing good is zero, price should be zero. Profit maximising firms will never provide a good for free.
How does market dominance lead to allocative inefficiency?
Allocatively efficient output level is where P=MC, however when firms have market dominance, they have price-setting ability, and hence set the price where MC=MR to maximise profit. P>MC, there is underproduction and consumption of the good, sum of consumer and producer surplus falls, no allocative efficiency.
How does market dominance lead to productive inefficiency?
With market dominance, firms can retain supernormal profits, thus can be X-inefficient due to complacency. They do not incur lowest LRAC possible, resulting in wastage of resources and productive inefficiency.
How does market dominance lead to dynamic inefficiency?
Due to high barriers to entry, firms may not have the incentive to engage in R&D, product quality falls over time, resulting in dynamic inefficiency.
What are the two types of immobility of factors of production?
- Occupational immobility
2. Geographical immobility
What is occupational immobility?
Barriers to moving factors of production between different sectors of the economy, resulting in some factors being unemployed. For example, labour often experiences occupational immobility because occupation-specific skills may not be easily transferrable, resulting in unemployment or underemployment, wasting resources. Demand for goods in certain industries may fall, resources may be unutilised or underutilised, wasting resources.
How does occupational immobility lead to market failure?
Labour often experiences occupational immobility because occupation-specific skills may not be easily transferable, resulting in unemployment or underemployment, wasting resources. Demand for goods in certain industries may fall, resources may be unutilised or underutilised, wasting resources.
What is geographical immobility?
Barriers to labour moving from one area to another to find work, due to family and social ties, financial costs involved in moving, huge regional differences in house prices and differences i the general cost of living between different regions.
How does geographical immobility lead to market failure?
Discourage labour from moving into area with shortage of labour, while perpetuating high unemployment rates in other areas. Actual output is less than potential output. The longer people are unemployed, the less likely they retain their skills. Unemployment represents a waste of resources.
What is inequity?
Unfair distribution of essential goods and services.
What are the causes of inequitable distribution?
- Excessive income inequality
2. High prices of essential goods and services in the free market
How does excessive income inequality lead to inequity?
Causes market to channel more resources to providing normal and luxurious goods due to high effective demand from higher income groups and produce fewer essential goods due to lower effective demand by lower income groups.
How do high prices of essential goods and services lead to inequity?
Lower income groups are unable to afford and gain excess to these goods and services.
How can inequality be represented?
- Lorenz curve: 45 degree line is the line of perfect equality. The further a line deviates from it, the greater the income inequality.
- Gini coefficient: ratio of area of deviation over area under the line of perfect equality. Greater deviation of Lorenz curve, larger Gini coefficient, higher income inequality. Range is from 0 to 1.
What causes wage inequality?
Demand for labour service being high relative to supply.
Workers being more productive and generating higher returns, more educated and skilful and possess some innate talent have more limited supply and hence earn higher wages.
What are the causes of income inequality?
Presence of unequal factor endowment means free market mechanism can yield large non-wage incomes for those who possess valuable financial assets and physical assets. They receive high non-wage income due to luck. Those with low wages have little ability to save and hence cannot accumulate financial and physical assets to earn non-wage incomes.
What are the effects of income inequality and inequity?
- Inequitable distribution of resources: poor are unable to afford essential goods or services
- Unequal access to opportunities: rich people have better connections, better education which could mean better job security and higher income. Inequality causes lack of social mobility, income inequality persists, unequal access to opportunities persist.
- Others: political and social instability, poor prosperity of country, bad health and mental wellbeing, reduced social cohesion.
Rational decision making by a government:
Objective: maximise society’s welfare
Constraints: budget, scarce resources
Information: need both quantitative and qualitative information about potential costs and benefits
Perspectives: needs to consider the impact and reaction of households and firms and other stakeholders
Benefits: monetary vs non-monetary, short run vs long run social benefits, externalities
Costs: opportunity costs, short run vs long run social costs, externalities
Decision making: MSB=MSC or total social benefits against total social costs
Intended consequences
Unintended consequences: aris due to imperfect information and changing economic conditions
Changes: evaluate outcome and decide whether to continue or change decision
What are the measures used by governments to address externalities?
- Taxes and subsidies
- Legislation and regulation
- Direct provision of goods that are under-consumed/produced
Taxes on negative production externalities:
Government can levy a per unit production tax equivalent to the MEC at the socially optimal output level. MPC curve will shift up to be the same as MSC curve. Market price increases, Qdd decreases. Effective price for suppliers decreases, Qss decreases. New equilibrium quantity where MSB=MSC reached.
What is the difference between tax on output and tax on pollutants?
Tax on output increases unit cost of production, incentivising producers to reduce supply.
Tan on pollutants creates incentive to buy fewer polluting resources and switch to less polluting technologies.
Taxes on negative consumption externalities:
When tax equal to MEC is imposed on producer, MPC increases, illustrated by an upward shift of the MPC curve. Market price rises, Qdd drops to socially optimal output. Efficient allocation of resources is achieved and deadweight loss is eliminated.
What are the advantages of taxes?
- Provides revenue for redistribution purposes
- Provide flexibility and financial incentives for behavioural changes, consumer sovereignty still present as market still operates according to market forces
What are the disadvantages of taxes in managing externalities?
- Indirect taxes are regressive and hence inequitable and undesirable
- Government needs accurate and complete information on the size of the external costs, but externalities are difficult to quantify. With lack of precision, welfare cannot be maximised.
- Government intervention may result in unintended consequences, such as perverse incentives and unexpected drawbacks.
Subsidies on positive production externalities:
With subsidies, MPC is lowered, illustrated by a downward shift in MPC curve towards the MSC curve. Producers receive a higher post subsidy price, and are hence incentivised to increase output to socially optimal output level. Deadweight loss is eliminated.
Subsidies on positive consumption externalities:
With indirect subsidies, MPC is lowered, illustrated by a downward shift in MPC curve towards the MSC curve. Price paid by consumers decreases and post-subsidy price received by producers increases, correcting under-consumption as equilibrium quantity increases.
With direct subsidies, MPB curve shifts up toward MSB, because consumers are more able to increase consumption, leading to higher effective demand, output is at socially optimal level.
What are the advantages of subsidies?
- Popular and can be easily implemented.
2. Consumer sovereignty is still present since the market can still operate.
What are the disadvantages of subsidies?
- The value of the external benefit is difficult to quantify, allocative efficiency may not be achieved.
- Subsidies can impose a huge burden on the government and taxpayers
- Large opportunity costs
Legislation on negative consumption externalities:
Prevents or limits consumer activities that impose costs on third parties, shifting MPB curve leftwards, towards MSB, achieving socially optimal output level.
Legislation on positive consumption externalities:
Legislation can be used to promote greater consumption of goods with positive externalities, shifting MPB curve rightwards towards MSB, achieving socially optimal output level.
Production quotas on negative production externalities:
Production quota imposed at socially optimal output level.
What are the advantages of legislation in addressing externalities?
- Simpler to implement
2. Greater certainty in achieving its targeted output level
What are the disadvantages of legislation?
- Price mechanism could be displaced, onus lies on the government to predict the socially desired level of output. Government suffers from imperfect information, thus legislation can only be partially effective at achieving the socially optimal level.
- Enforcement of laws is difficult and expensive and penalties for breaking laws must be sufficiently harsh.
Tradable permits system on negative production externalities:
Permits to pollute are issued by the government and can be traded, supply curve is perfectly price inelastic. Price of permits determined by market forces of demand and supply. Buyers of permits penalised for polluting, seller of permits rewarded for reducing emissions.
What are the advantages of a tradable permit system?
- Greater certainty in achieving desired level
- More cost effective than regulation
- Encourages the promotion of cleaner and greener technology
What are the disadvantages of a tradable permit system?
- Many technical difficulties, difficult to measure optimal level of emissions
- High administration costs, more firms, more difficulty in enforcing policy, more regulators needed to be employed
- Governments may give preferential treatment to supporters
- Market dominance, small number of firms buy up all permits, increase barriers to entry.
Joint provision by the government:
Government supplements what is being provided by the private sector because free market equilibrium level is lower than socially optimal level. Market supply increases, market output thus increases to socially optimal level, allocative efficiency is achieved. Lower prices allow low income households to access the good.
Direct provision by the government:
Done to ensure equitable distribution when there is excessive income inequality or significant positive externalities. Quantity demanded increases to socially optimal level.
What are the advantages of direct provision?
Government has direct control over the supply of the good or service, and thus can control not only the quantity but also affordability and quality.
What are the disadvantages of direct provision in addressing externalities?
- Governments are unable to perfectly correct underconsumption because it is difficult to measure the size of external benefits and extent of underconsumption.
- Production may be inefficient as employees of the state have no incentive to keep costs at a minimum due to the lack of profit motive.
- Involves use of government funds, thus opportunity cost is incurred.
- Government needs to be aware of the costs of crowding out private sector activity.
What are the measures used by the government to address zero provision of public goods?
- Direct provision of public goods
Explain direct provision of public goods:
Government funds goods and provides these goods through taxes. To decide whether or not to produce an additional unit, government weighs MSC against MSB and produces until MSB=MSC.
What are the advantages of direct provision of public goods?
- Without it, public goods will not be provided. A missing market may indicate significant loss to society’s welfare.
What are the disadvantages of direct provision of public goods?
- Benefits and costs of providing public goods are often highly uncertain, for example it is difficult to measure the MPB from the provision of public because there is no effective demand. Demand is estimated through surveys but the free rider problem incentivises consumers to conceal their willingness to pay. Allocative efficiency might thus not be achieved.
- Direct provision of public goods is financed through taxes, thus opportunity costs will be incurred.
What are the measures to regulate market dominance?
- Legislation
- Price regulation
- Taxes and subsidies
- Nationalisation
What are the types of legislation that can regulate market dominance?
- Reducing barriers to entry
- Anti-trust laws
- Laws that demand firms conform to certain standards of provision
How does reducing barriers to entry regulate market dominance?
Increases competition and lowers prices of goods as demand of prices falls and becomes more price elastic.
What are the advantages of reducing barriers to entry to regulate market dominance?
- There is a reduction in the difference between the existing firm’s profit-maximising price and marginal cost, decreasing incentive to be X-inefficient.
What are the disadvantages of reducing barriers to entry to regulate market dominance?
- Lower profits affect the firm’s ability to do R&D, quality and choices may stagnate in the future, adversely affecting dynamic efficiency.
How do anti-trust laws regulate market dominance?
Promote or maintain market competition by regulating anti-competitive conduct by companies, to curb collusive behaviour. Laws prohibit restrictive practices that lead to a firm acquiring a dominant position in the market, and supervise mergers and acquisitions (transactions that threaten the competitive process can be prohibited).
What are the disadvantages of anti-trust laws on regulating market dominance?
- Expensive and difficult to prove that companies are engaging in anti-competitive behaviour.
How do laws that demand firms conform to certain standards of provision regulate market dominance?
Ensure there is guaranteed quality of product or service provided in monopoly markets.
What are the disadvantages of laws that demand firms to conform to certain standards of provision to regulate market dominance?
- Regulations are difficult and expensive.
How does price regulation regulate market dominance?
MC pricing (P=MC): social optimum is achieved because MB=MC, but since AC>AR, firm may face losses unless government subsidises producer. AC pricing (P=AC): firms are able to break even but allocative efficiency is not achieved as socially optimal output is not reached.
What are the advantages of price regulation to regulate market dominance?
- Reduce price and increase output, consumer surplus increases.
What are the disadvantages of price regulation on regulating market dominance?
- Dilemma facing the regulator
2. Revenue and cost curves can only be estimated by the government, regulated firm may overstate cost
What are the taxes and subsidies given to regulate market dominance?
- Lump sum tax to reduce excessive monopoly profits
2. Indirect subsidy to increase monopoly’s output towards AE level
How does lump sum tax regulate market dominance?
Lump sum tax is a fixed cost, thus it will shift the AC curve upwards, profits are reduced.
What are the disadvantages of a lump sum tax to regulate market dominance?
- While it reduces income inequality, it may conflict with other economic objectives such as economic growth and efficiency.
How do indirect subsidies regulate market dominance?
Shifts MC curve rightward, output increases to socially optimal level.
What are the disadvantages of indirect subsidies to regulate market dominance?
- Subsidies may further increase supernormal profits of monopolists and hence worsen income distribution.
How does nationalisation regulate market dominance?
Ownership is transferred away from private sector to government.
What are the advantages of nationalisation?
- Government can act in the interests of the public to promote equity, ensuring prices are low and output is greater than in an unregulated monopoly.
- Nationalisation results in higher investment as government provides funds.
- Nationalisation can protect strategic industries.
What are the disadvantages of nationalisation?
- Nationalised industries tend to be more inefficient than privatised industries as other objectives tend to be more important than maximising profits.
- Nationalised industries are prone to suffer from moral hazard, which occurs when individuals or organisations are insured against the negative consequences of their own inefficient behaviour.
What are the measures to manage information failure?
- Education and campaigns
2. Government legislation and regulation
How do education and campaigns manage information failure?
Cause private demand to move to the socially desirable levels, causing firms to produce at levels that correspond to socially optimal output.
Governments have to supply information to consumers so that there is no asymmetric information.
What are the advantages of education and campaigns to manage information failure?
- If information failure is the root cause of market failure, education and campaigns target the root cause of market failure.
What are the disadvantages of education and campaigns to manage information failure?
- Difficulties involving accurate collection and accurate dissemination of information.
- Costly, may drain government resources.
- Ineffective in the short run as mindsets require a long time to change.
What are the legislations and regulations to manage information failure?
- Laws to address the adverse selection problem in the goods market
- Laws to address adverse selection problem in the health insurance market
- Laws to address moral hazard problem
How do laws that address adverse selection problem in goods market manage information failure?
The government can pass consumer protection laws, such as the lemon law, which protects consumers against defective goods that fail to conform to contract, or meet satisfactory quality or performance standards at the time of purchase. Seller of defective product must repair, replace, refund or reduce the price of the defective product, reducing their incentive to lie about the quality of the product.
What are the disadvantages of laws that address adverse selection problem in goods market?
- Sellers might opt not to sell their products in countries with the lemon law.
How do laws that address adverse selection problem in health insurance market manage information failure?
Government has made it mandatory for Singaporeans to participate in MediShield Life, a social health insurance to provide lifelong coverage of medical care to Singaporeans. By making participation mandatory, adverse selection gaps found in voluntary and opt out schemes can be avoided.
Consumers required to provide accurate and complete information or they will not be eligible for their pay out benefits. Government allowed to access income and medical records of all Singaporeans to calculate premiums and subsidies each individual is eligible for.
What are the disadvantages of laws that address adverse selection problem in health insurance market?
- MediShield Life scheme can lead to medical professionals pressuring patients to opt for unnecessary medical care which can result in moral hazard of healthcare consumption.
- Lack of privacy demanded by the MediShield Life Scheme Act appear onerous because financial and health details are extremely personal.
How do laws to address moral hazard problem manage information failure?
Government makes it compulsory for the buyer of the insurance to pay for part of the cost of damages or make partial payments for healthcare bills compulsory. Buyer has less incentive to engage in irresponsible or risky behaviour.
What are the disadvantages of laws to address moral hazard problem?
- While it can prevent overconsumption of healthcare services and increase awareness of treatment costs, it can prevent the sick and disadvantaged from accessing needed care, the poor are unable to afford healthcare.
What are the policies to ensure greater income equality and equity?
- Policies to reduce wage inequality
2. Other policies to help the lower income group
What are the policies to reduce wage inequality?
- Minimum wage law
- Measures to increase productivity of workers
- Measures to reduce supply of low skilled workers
- Taxes and subsidies
How does the minimum wage law ensure greater income equality and equity?
Minimum wage is set above equilibrium wage rate, helps lower-income workers and reduces wage inequality. However, employment will fall as firms reduce the quantity demanded for labour. Those who retain their jobs have higher wage, those who are retrenched are worse off.
How do measures to increase productivity of workers ensure greater income equality and equity?
Demand for high skilled workers is higher if workers are more productive. If low skilled workers increase their productivity, they can find employment easily at higher wage rates. Can be done through skills upgrading schemes.
How do measures to reduce supply of low skilled workers ensure greater income equality and equity?
A large supply of low skilled labour can dampen wage rates. Supply can be reduced by restricting the number of low skilled labour from overseas. Singapore imposes a higher levy on the employment of foreign workers and restricting the issue of work permits, increasing wage rates. As wage rates at the lower end of the income earners increase, widening of income gap in society is prevented.
How do taxes reduce ensure greater income equality and equity?
A progressive tax system redistributes income and wealth from the rich to the poor.
What are the disadvantages of taxes on reducing income inequality?
- High income tax reduces the reward to individuals for their work effort and savings, reducing the quantity of labour in the market and willingness to save.
- High administrative costs of running redistribution programme
How do subsidies ensure greater income equality and equity?
Cash benefits: subsides to a person’s income such as childcare benefits, income supplements given to low income families and old age pensions paid out to retirees
Benefits in kind: goods and services which may be provided for free or at a reduced price to low income households such as subsidised healthcare at public clinics and hospitals and free transportation and food vouchers given to low income families.
What are the disadvantages of subsidies to reduce income inequality?
- Usually financed with tax revenue and can drain government finances.
What are other policies to help the lower income group to ensure greater income equality and equity?
- Price controls in the market for necessities
2. Government provision
How do price control in the market for necessities ensure income equality and equity?
Ensure that the poor have access to these basic essentials.
Rent controls: price ceiling on rent. Landlords may cut maintenance costs and let their property fall into disrepair.
Price supports on grain: help poor farmers sell their crop at minimum price. May bring little benefit if large wealthy farmers are the main producers and stand to gain most from minimum price implemented.
How does government provision ensure income equality and equity?
Main causes of poverty are lack of education and inadequate provision of healthcare, preventing individuals from achieving satisfactory levels of incomes. If government devotes more resources to expenditure on education and health, root causes of poverty can be tackled, reducing income inequality.
What is government failure?
Situation where government intervention in the free market increases market distortions and reduces economic efficiency and welfare, leading to worsened allocation of resources.
What are the reasons for government failure?
- Unintended consequences that are not addressed
- Imperfect information: government miscalculates benefits, costs, prices etc., implement policies that do not lead to efficient outcomes.
- The bureaucracy and inefficiency of government intervention: government intervention involves administrative costs, if too many resources employed or used inefficiently, economic welfare reduces
- Time lags: takes time for government to recognise that market failure s occurring and to implement appropriate policies. By then, problems may have become acute or economic circumstances have changed, requiring new and more radical measures.
- Shifts in government policy: if government intervention changes too frequently, it is difficult for firms to plan ahead and allocate their resources efficiently.
- Rent seeking: corrupt government officials maximise their own self interests.
How can behavioural economics be used to improve the outcome of government intervention in markets?
- Increasing salience: ensure policy is noticeable to economic agents
- Ensuring convenience: government must ensure that the intended option is the most convenient one
- Appealing to loss aversion:
Limitations: behavioural nudges build on existing policies, not meant as a substitute for existing policy tools.
Policies to solve traffic congestion and air pollution (negative externalities in producing a car journey):
- Congestion charges (ERP)
- Output controls (COE)
- Providing quality transport system
- Supplying a comprehensive road network and maximising its capacity
Government intervention in education in Singapore:
- Compulsory education
- Local public schools and international public schools
- Heavily subsidised school fees for locals at local public schools
- Personal Edusave
- Financial assistance
- Making preschool more affordable and accessible
- More places for preschools
- More will pay less
- Supporting low income families
