Government

Failure
WHEN THE COST OF
I N T E RV E N T I O N O U T W E I G H S
T H E B E N E F I T S T H AT O C C U R
BECAUSE OF THE
I N T E RV E N T I O N . A S A R E S U LT,
T H E R E I S A M I S A L L O C AT I O N
OF RESOURCES AND
F U RT H E R L O S S O F E C O N O M I C
A N D S O C I A L W E L FA R E
Why do governments intervene In
markets
- To try and combat market inequalities through regulation, taxation and subsidies

- Government also intervene in markets to promote general economic fairness.

- maximising social welfare (breaking up monopolies).

- Promote other goals such as national unity and advancement.

Causes of Governments Failure
1) Admin costs are high, really high. E.g. regulatory bodies (Ofgem and Ofcom). All government setup
firms to regulate markets and ensure there is no abuse in like monopoly markets etc. To run these its
costs a lot and if the costs outweigh the benefits from these firms this may be deemed as government
failure.

2)Information problems – if there is information gaps in the market the governments might also not
have full info therefore might make the wrong choices which might make things worse e.g. If the
government try to intervene in environmental market failure it needs to know what the socially
optimum is. But this is not possible information so the government might make the wrong choice and
make things worse.
Causes of Governments Failure
3) Unintended Consequences – e.g. if there is a fishing limit on how much fish you can catch and
fisherman catches more than it was supposed to. He/she may throw these fish back in the water and
these may be dead fish so they are not beneficial to anyone they are actually a cost.

4) Conflict of objectives – A government might regulate the gas monopoly market. The whole point is
to bring prices down and make market more competitive. BUT environmentalists might say they want
prices lower to reflect the high negatived externalities involved in the process.

If regulatory capture takes place , when a regulatory firm bonds with the monopoly firm then
government might fail as the R firm might just do the opposite of what it was told to do by the
government and might make things worse.
 Examples and definition
Public choice theory – This is the theory that suggest politicians act in a way that maximises their own utility
without bothering about if this decision increases societal welfare. E.g. Politicians in office who are fighting to get re-
elected may implement policies which benefit their own electors at the expense of the welfare of all other citizens.

Regulatory Capture – This is when government run regulatory firms become dominated or persuaded by the
industry they are regulating. They are in charge of making industries act in public interest ,Instead they might in ways
that act in ways that benefit the industry it is supposed to be regulating. E.g. a gas firm might bond with a regulatory
firm and try to get make their restrictions looser.

Shadow market/Black Market – If the government intervene in sectors where the product they sell is deemed to
have a addictive nature they may create black markets. \this is an illegal trade in officially controlled or scarce
commodities. E.g. The use of Class A drugs has been made illegal by the U.K. government therefore creating a black
market where unofficial sources of Class A drugs are supplied at higher prices.
Shadow market/Black Market – If the government intervene in sectors where the product they sell is deemed to have
a addictive nature they may create black markets. \this is an illegal trade in officially controlled or scarce commodities.
E.g. The use of Class A drugs has been made illegal by the U.K. government therefore creating a black market where
unofficial sources of Class A drugs are supplied at higher prices.

Excessive Administration Costs - sometimes the administrative cost for correcting market failure is so large that it
outweighs the welfare benefit from the correction of market failure. E.g. if its cost £5 to pay out a £3 benefit ,it will
cause market failure.

Unintended Consequence - Some interventions by government create unintended consequences. E.g. When member
countries of the European Union first implemented a Common Agricultural Policy (CAP) in 1962, they did not for see
what a boost it would give to agricultural production. The result was in the 1970s and 80s , that consumers paid way
higher prices than if this policy did not exist.

Information Gaps – Governments like all other economic agents rarely possess complete information on the decisions
they make. In some cases the information can be very misleading and lead to government making wrong decisions. E.g.
A government may decide to spend millions of pounds building a new road bridge, thinking that this will bring more
jobs and attract tourism and lower cost of traveling. BUT costs of making the bridge maybe underestimated and the
benefits from the bridge maybe overestimated. Hence resulting in government failure.
: Alternative form of government intervention – Behavioural
economics. Is there a better way than tax to get people to stop
drinking, better way to reduce speeding than speed cams?
What is ‘choice architecture’