Evaluate why governments intervene in market outcomes

Government intervention is when a government decides to alter the conditions of a market in order to
adjust market outcomes. Governments may do this for many reasons; they may believe that the
current market outcome worsens inequality, marginalises a section of society, or to fulfil election
campaign promises. Governments can intervene in markets in many ways, including setting limits on
price, such as the minimum wage and rent controls, stabilising the price through the careful storage
and release of a product, usually food, or through regulation and legislation.

Beginning with price limits, the minimum wage was introduced in Britain in 1999, and has remained
ever since. Originally, the minimum wage was introduced to try to improve living conditions for the
working class in society, who would be payed very little for often difficult jobs, such as hard labour in
manufacturing. The below diagram illustrates the effect of introducing a minimum wage on the

market:
Before the minimum wage was introduced, the market equilibrium was at P1, where supply met
demand; i.e. the price that the labour market was collectively willing to work for, and the price the
suppliers were willing to pay for. Here, the labour market is represented by the curve S1, and the jobs
sector is represented by the curve D. When the market was at equilibrium, Q2 quantity of workers
were employed, but, when the minimum wage was introduced (Minprice), only Q1 workers were
employed, but Q3 workers wanted a job at that price. This leads to an issue where supply is larger
than demand – there are more workers than jobs. As such, raising the minimum wage can lead to
unemployment. While yes, living conditions will be improved for those workers still employed, but is
that worth losing Q2-Q1 workers, and forcing them to become unemployed? This issue can be offset,
however. If the government does institute or raise the minimum wage, it is highly unlikely that that is
the only policy change they will be instituting. A raise in the minimum wage could be accompanied
by, for example, subsidies for businesses, encouraging them to employ more minimum wage workers,
effectively making the government pay for, if not all of, then at least a part of, the increase in the
wages from raising the minimum wage. This has the effect of increasing wages, whilst still retaining
employment, raising standards of living and quality of life for all, right? Well, not entirely.
Unfortunately, such large scale policies such as this can lead to increases in inflation, offsetting the
increase in wages brought by raising the minimum wage. Allow me to explain. Because the
government has raised the minimum wage, workers will have more money. Some businesses, seeing
that people are spending more money, and are willing to pay more (their consumer surplus) because
their wages have gone up, will raise their prices in order to make more profit. Should this either
happen in a large scale across the economy, or in a key product, such as grain, all the prices in the
economy may increase, raising the general price level, and therefore causing inflation.
Now, we move on to setting an upper price limit on a good or service. Rent controls are a good
example of this. The below diagram displays the effects of introducing a price cap on the market:

The market equilibrium here is P – the price at which tenants are willing to pay and the price at which
the landlords are willing to supply for. However, should the government decide that these prices are
too high, they may impose a price limit – a rent control. This will have the effect of reducing the price
from P to Pmax, and causing demand to exceed supply. The quantity demanded at Pmax is Q2 and
has increased because more people will be able to afford the now lower rent costs, but the landlords
are only willing to supply Q1 amount of housing at the new maximum price the government has
imposed. This causes market failure, as supply cannot meet demand. This may cause homelessness to
increase, as the supply of housing has decreased, while demand has increased. The government could
rectify this imbalance in a similar fashion to the solution to the minimum wage problem – by
subsidising the landlords. In effect, the government would pay a portion, or the entirety, of the fall in
rent for the landlords, effectively offering more accessible housing to the population whilst also
maintaining the supply of housing. This scenario shouldn’t lead to too much inflation, as landlords
will still be unable to charge more than the price limit, which effectively caps the amount of inflation
which can be caused.

Next, we will discuss price stabilisation through the careful storage and release of a product. The
government usually uses this form of market intervention with food and agricultural harvests.

The above diagram displays the effects of this method of government intervention on the market. The
price range that the government believes the food should be sold at is highlighted in green. In the
event of an abnormally good harvest, the government will buy the farmer’s produce within their target
price range, protecting farmers from lower market prices due to an excess of supply. However, should
a poor harvest occur, with low yields, the government will release their stored stock in an attempt to
lower the now inflated prices for the consumer. This is a tidy solution to the problem; it protects both
farmers and consumers, and usually doesn’t require any extra legislation along with it in order to
balance the equation, as with rent controls and minimum wages.

Finally, we will discuss the effectiveness of the regulation and legislation of demerit goods in an

attempt to reduce demand for them.

As the above diagram very effectively displays, the demand curve for addictive substances such as
cocaine is not actually straight – it is curved. This is due to the nature of the substance. With cocaine,
there will be recreational users, who don’t have a very high consumer surplus – i.e. they’re not willing
to pay very much over the odds in order to obtain the cocaine. However, the addicts have an
enormous consumer surplus – they’re willing to pay almost anything in order to secure their next hit.
As such, the demand curve is very inelastic at low demand levels, but then levels off to become more
inelastic as the demand becomes more filled out with recreational users rather than just the addicts.

Should the government attempt to introduce regulation to prohibit the supply of cocaine, the effect
would be limited. The legislation would probably be effective at reducing the recreational use of the
drug, but would be fairly futile at reducing the cocaine consumption of a cocaine addict. Furthermore,
should the government attempt to ban cocaine entirely (assuming it was legal at S0), they would
merely move the supply curve to S1 and create a black market for the drug, which cannot be
regulated. As such, while the regulation of cocaine would reduce recreational demand, it would
actually make the situation worse for cocaine addicts, who now are forced to go to black market
dealers to get the drug, where it cannot be regulated, and therefore is more dangerous. However,
should the government attempt a softer approach, allowing the sale of cocaine, then they could enact
legislation to regulate the ingredients of the drug, in order to make it safer for consumption, and
ensure that the ingredients are healthy. Furthermore, regulating the cocaine market would help reduce
the extortionary practices undertaken by many dealers, as they know that an addict would be willing
to pay almost anything for their next hit of cocaine.

Therefore, the government can intervene in market outcomes in many different ways. Each of these
methods has its advantages and disadvantages, and each could be the best solution, depending on the
situation. In essence, however, governments intervene in market outcomes in order to change the
outcome to a result that the government views to be better or more advantageous.