Market Failure-Government Intervention
Government embarks on direct provision of public goods because they are not provided by the private sector. They are not attractive to the private sector because people can have access to them without paying. That is to say, they are non-excludable.
Also, government can provide merit goods due to the inability of the free market to provide them in sufficient quantities and at affordable prices, e.g. public schools. Direct provision by the state increases government spending and may result in budget deficit. Government may have to borrow to finance the provision of these goods.
A tax is a form of financial intervention by the government for goods that generate negative production or consumption externalities. The imposition of taxes is used to reduce the quantity of demerit goods produced or consumed in the economy. Demerit goods are often over-produced because the price mechanism does not consider the external costs they impose on third parties. The amount of the tax should be equivalent to the value of externalities generated by a producer that pollutes the environment or an individual that consumes demerit goods. Taxes will provide a way of internalising the external costs, reduce free market quantity and bring it as close as possible to the socially optimal quantity. The taxes are capable of reducing negative externalities and improving economic welfare. The major problem is the difficulty in accurately valuing external costs imposed by demerit goods. The elasticity of demand of the product also determines whether consumption will fall to the socially optimal quantity. Quantity demanded will fall slightly as a result of price increase caused by tax if demand in inelastic.
Progressive income taxes can be used to reduce income and wealth inequality. High income earners are required to pay higher tax rate. The taxes raised can be used to pay benefits to low-income earners or finance goods and services such as healthcare and education. High taxation can be a disincentive to work and benefits may not be claimed by those who need them.
Subsidies are financial incentives given in respect of goods with external benefits, e.g. merit goods. These goods are usually under-produced. The amount of the subsidy is the estimated value of the positive externality derivable form the product. Subsidies help to cover part of the cost of production, expand supply and drive down prices. If the product has an inelastic demand, price reduction will lead to a smaller percentage rise in quantity demanded. It in more effective for products with relatively elastic demand because a price fall will lead to a greater percentage rise in the quantity demanded. It is very difficult to correctly estimate the external benefits arising from consumption. Therefore, the amount of the subsidy may be inadequate or too much. In addition, a lot of finance is required to sustain the policy.
Regulation and deregulation
Regulation involves the use of standards, rules or laws to control the quantity and quality of products. Regulations can be used to reduce negative externalities such as the compulsory use of catalytic converters to reduce pollution generated from vehicles or pollution permits that limit amount of pollution businesses can produce. Regulations can also be used to encourage the use of goods with positive externalities, e.g. compulsory education. Antitrust laws, for instance, help control monopolies and encourage more competition in the market. The benefits of regulations must outweigh the administrative costs required to ensure compliance.
Deregulation means reducing the amount of regulations in order to promote competition and prevent emergence of monopolies.
Provision of information
Government can prevent information failure through education, awareness campaigns and advertisements. This will ensure people are fully aware of the benefits or costs associated with the consumption of certain products. It will discourage over-consumption of demerit goods and encourage the consumption of merit goods. The costs involved must be weighed against the benefits. In addition, it may take time for them to have the anticipated impact.
Granting property rights
Government can grant the ownership of resources to firms or people so that actions can be taken to reduce negative externalities. For example, the ownership of a river can be granted to the community so that it can sue firms that pollute it. Property rights extension can lead to compensation of those who suffer from externalities.