government-intervention-an-introduction

Reasons why Government Intervene

• Nearly every economy in the world is a mixed economy and has varying degrees of government intervention

• One of the main reasons that governments intervene in markets is to correct various market failures

Diagram: Reasons for Government Intervention 

1. To correct market failure

• In many markets, there is a less than optimal allocation of resources from society’s point of view, resulting in market failure

• Market failure can occur for a number of reasons, e.g. externalities, overconsumption of demerit goods or monopoly power

• In maximising their self-interest, firms and individuals will not self-correct this allocation of resources and there is a role for the government

• To prevent market failure, a government can intervene to improve the economic performance of firms and markets and influence the level of production or consumption

2. Redistribute income and wealth 

• Intervention seeks to achieve a more equitable (fairer) distribution of income and wealth to improve lives of citizens

• Taxing the rich to support poorer households can reduce poverty and have impacts on individuals and the economy

3. Support firms 

• In a global economy, governments choose to support key industries so as to help them remain competitive

4. Collect tax revenues 

• Governments need money to provide essential services, public goods and merit goods

• Services can be paid for with revenue raised through interventions such as taxation, privatisation, sale of licences (e.g. 5G licences), and sale of goods/services

5. Achieve macroeconomic objectives 

• Macroeconomic objectives are centred on improving the overall performance of the economy and living standards for the population as a whole

• Government intervention in markets can influence economic stability and promote economic growth

• E.g By providing essential public health services, the government can improve the health and therefore, living standards of citizens

Government Objectives & Resource Allocation

• Government (state) involvement aims to improve the efficiency of markets by altering the allocation of resources

• The level and type of intervention used depend on the government’s macroeconomic objectives

  • Free-market economists argue that government intervention should be limited to all but the most basic services such as the provision of national defence

  • Other economists argue that the government should intervene in all areas of the economy to ensure the most efficient and equitable distribution of resources

Common Types of Intervention to Correct Market Failure

• There are a number of ways in which governments can intervene to correct market failure and influence the allocation of resources

• The microeconomic and macroeconomic objectives of a government also affect how governments intervene in an economy

• Governments can implement market-based and non-market based policies

  • Market-based policies involve the government taking action to affect the conditions of supply or demand and therefore price and output, e.g. by offering subsidies

  • Non-market based policies occur when the government directly intervenes in the market, e.g. by legally enforcing regulations such as smoking bans or direct state provision (e.g. NHS)

Diagram: Common Types of Intervention to Correct Market Failure

• The main ways in which governments intervene are classified as:

  • Public expenditure

  • Taxation

  • Price controls

  • Legislation and regulation

Examples

• The UK government provides subsidies to consumers to purchase electric vehicles

  • The subsidy lowers the relative cost and may incentivise consumers to purchase an electric car. If there is increased demand, producers may allocate more resources to producing these goods

• The UK government has set a price cap (maximum price) that energy suppliers can charge consumers for a unit of energy. This is to ensure that energy prices are fair

  • The Office of Gas and Electricity markets (OFGEM) regulates this market