2.2.1

Government Intervention in Markets

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Market Failure - Reasons for Government Intervention

The free market can result in a misallocation of resources (or market failures). Governments can intervene to correct these market failures.

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Meeting basic needs

  • In a market-based economy, a consumer's ability to consume goods and services depends on their income and wealth.
  • If a consumer has a low income, they may not be able to afford basic goods to satisfy their needs.
  • The market is under-providing these goods and this can be a source of market failure.
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Underconsuming merit goods

  • Governments may want people to consume more things like education, which have positive externalities.
  • Subsidies or free state provision may be used to encourage the consumption of merit goods.
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Overconsuming demerit goods

  • Demerit goods like cigarettes may be overconsumed.
  • Taxes or bans may be interventions to solve this issue.
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Irrationality

  • The UK government has a Nudge unit, which implies that consumers may not be rational agents and need guidance.

Indirect Taxes - Government Intervention

A government may use indirect taxes to correct market failures. An indirect tax is a tax on household spending and consumption and is applied to goods and services.

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Cigarettes as market failure

  • Smoking may be a form of market failure because:
    • People are unaware of the negative impact of cigarettes on their health.
    • The negative externalities of smoking are not considered by consumers.
    • People may not be rational (they may be myopic or short-termist).
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Taxing cigarettes

  • Governments can implement an indirect tax on goods.
    • E.g a tax on cigarettes.
  • This raises the cost of production, shifting the supply curve towards a more socially optimal level.
  • An indirect tax can either be specific, which is a parallel shift in the supply curve, or ad valorem, which is a non-parallel shift.

Jump to other topics

1Introduction to Markets

2Market Failure

3The UK Macroeconomy

4The UK Economy - Policies

5Business Behaviour

6Market Structures

7A Global Perspective

8Finance & Inequality

9Examples of Global Policy

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