Government Intervention in Markets
Economics: Edexcel A A Level, topic 2.2.1
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.
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.
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.
Overconsuming demerit goods
- Demerit goods like cigarettes may be overconsumed.
- Taxes or bans may be interventions to solve this issue.
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.
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).
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.
Test yourself on Government Intervention in Markets
Which of the following are reasons for government intervention in markets?
Which of the following is a reason why basic needs may not be met in a free market?
Which of the following is an example of an indirect tax?
Which of the following are examples of indirect tax?