State Intervention and Market Failure

Readers Question: State intervention is necessary to maximize social welfare but intervention often comes at a heavy price. So why not rely on the market system to tackle the problem?

It is one of the great debates of economics – How much should the government intervene in the economy.

Firstly we have to consider occasions where government intervention is necessary to improve economic welfare.

Types of Market Failure

  • Merit goods (e.g. education, under-consumed because people ignore benefits of it)
  • Demerit goods (e.g. alcohol, over-consumed because people ignore costs of it.)
  • Public goods e.g. street light (usually not produced in free market)
  • Externalities. External costs are not priced by free market, so will be over-consumed, e.g. pollution from driving
  • Monopoly. Monopoly power leads to higher prices and less choice for consumers.
  • Inequality.
  • Recession. Macro economic imbalances encourage government intervention.
  • Different types of Market Failure

Government Failure

Now the problem is that government intervention in the economy may create costs.

  • e.g. high administration costs
  • Government subsidy may encourage inefficiency.
  • Government failure

However, the fact that government intervention may cause high costs, is not a reason to leave everything to the free market. An economist would look at ways of maximising the benefits of government intervention. It would try to work out optimal level of government intervention.