government-intervention-other-methods

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State Provision to Correct Market Failure

Merit goods and public goods are under-provided in a free market, causing a market failure
Public goods are beneficial for society and are not provided by private firms due to the free rider problem
- They are usually provided free at the point of consumption, but are paid for through general taxation
- Examples include roads, parks, lighthouses, national defence
Merit goods are beneficial to society but consumers cannot always access them as they are priced out of the market (e.g. private education or healthcare)
To solve the market failure, governments can provide these goods and services

The Advantages & Disadvantages of State Provision

Advantages	Disadvantages
Essential goods and services are usually provided free at the point of consumption These goods and services are accessible to everyone, regardless of income These usually provide both private and external benefits to society	Paid for through general taxation There is an opportunity cost associated with their provision Products which are free may result in excess demand and long waiting times, e.g. procedures at Public hospitals or lenghty waits to see a GP

Regulation to Correct Market Failure

Regulation is the process of monitoring and enforcing laws to limit the harm caused by the external costs of consumption or production
Regulations can limit or prohibit certain behaviours to prevent market failure
Reasons for regulation include preventing exploitation of consumers, taking externalities into account, and reducing consumption of demerit goods
- For example, certain classes of drugs (demerit goods) are prohibited in the UK
- Collusion and cartels are banned by competition policy and regulated by the Competition and Markets Authority to prevent abuse of monopoly power

Regulatory agencies are created to enforce the law and ensure that the rules are not broken

Property Rights and Pollution Permits to Correct Market Failure

Property Rights

Common pool (access) resources are natural resources over which no private ownership has been established
- Left to the free market, common pool resources can be over exploited and used in an unsustainable way
- This results in the tragedy of the commons and environmental market failure

Property rights define the ownership of common pool resources and set out how they can be used
- By transferring common land over to private ownership, the private owner has a strong incentive to manage the resource and take care of it for future use
- This internalises the externality and can resolve tragedy of the commons related market failure

The Advantages & Disadvantages of Property Rights

Advantages	Disadvantages
Ensures that resources are allocated efficiently Reduces the harm caused by negative externalities External costs of overusing common access resources are taken into account	Difficulty in allocating and dividing up some resources Air is a difficult resource to distribute Difficult to allocate rights in a fair (equitable) way Regulating and enforcing the property rights is expensive

Pollution Permits

Governments calculate an optimum (or preferable) level of pollution
Governments create a pollution permit market and issue permits to polluting firms
- The price of the permit is determined by demand and supply
- Each permit allows a firm to pollute up to a certain amount. Any surplus can be sold and traded for additional revenue
- Firms that pollute more have to buy additional permits from less-polluting firms

Diagram: The Pollution Permit Market

Diagram of two smokestacks. Company X exceeds emissions cap and buys permits from Company Y, which has unused permits below the cap. — **Firms can sell their unused pollution permits to generate extra company revenue**

The cost of the permit represents an additional cost of production, which should reduce supply and output closer to the socially optimal level
If the system works effectively, it can correct market failure by reducing the associated negative externalities
If the price of additional permits is more than the cost of investing in new pollution technology, firms will be incentivised to switch to cleaner technology

The Advantages & Disadvantages of Pollution Permits

Advantages	Disadvantages
May encourage firms to switch to green production methods in the long run, especially if that is cheaper than purchasing permits every year Raises government revenue from the sale of permits	Firms may relocate production to places where they can pollute without limits Expensive and difficult for firms to monitor emissions Firms may pass on higher production costs to the consumer

Advantages

Disadvantages

May encourage firms to switch to green production methods in the long run, especially if that is cheaper than purchasing permits every year
Raises government revenue from the sale of permits

Firms may relocate production to places where they can pollute without limits
Expensive and difficult for firms to monitor emissions
Firms may pass on higher production costs to the consumer

Examiner Tips and Tricks

If you are evaluating government intervention, explain how the specific intervention being used may solve market failure. Remember to use data from the context, if applicable, or your own examples to enrich your answer.

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