MICRO - LS23 - Government Failure

Question 1

Government failure

Answer 1

When government intervention designed to correct a market failure results in a less efficient allocation of resources

Question 2

Causes of government failure

Answer 2

• unintended consequences
• distorting of price signals
• excessive administrative costs
• information gaps

Question 3

Unintended consequences

Answer 3

• gov failure can arise through unintended consequences that result in a worse outcome then before gov intervention was implemented
  e.g. prohibition, high taxes on cigarettes, results in the black market of cigarettes

Question 4

Distorting of price signals

Answer 4

• max & min prices can result in shortages & gluts(surplus)
• gov have to then buy glut
• subsidies may result in lower prices & greater consumption of goods w/ external costs
  E.g. subsidies for sugar farmers
  Examples - Common Agricultural Policy (EU), subsidies for US farmers

Question 5

How does regulation aim to correct market failure?

Answer 5

• regulation provides an incentive to change behaviour toward the socially optimal level of output
• if correctly implemented this leads to the removal of welfare loss (or a welfare gain for positive externalities)

Question 6

Disadvantages of regulation

Answer 6

• cost - regulation is costly in 2 aspects - administration & enforcement
• setting the right level of regulation can be difficult
• may encourage black market activity
• unintended consequences may arise

Question 7

Excessive administrative cost

Answer 7

• admin costs of government intervention may outweigh any benefits that result from it
  Example: drug prohibition

Question 8

Information gaps

Answer 8

• lack of sufficient information can lead to government intervention being set in an ineffective manner
  Examples: promotion of diesel cars by European governments

Question 9

Guaranteed minimum pricing scheme

Answer 9

• where the surplus output created is purchased by a government agency at the minimum price
• main aim of such a scheme is to protect producer incomes

Question 10

Advantages of minimum pricing schemes

Answer 10

• producer’s incomes increase/stabilise —> greater investment & employment
• greater security for food supply (consumer)
• surplus can be stockpiled or used for aid for other countries

Question 11

Disadvantages of minimum pricing schemes

Answer 11

• surplus may be sold overseas at low prices
• could be damaging to farmers in developing countries that are likely struggling to compete
• opportunity cost if government finances (money spent buying excess supply could be used elsewhere) - may have to raise taxes/cut government spending im other areas
• difficult to set price at the right level - may be information gaps, storage & security costs for the stockpiles