Government and Market Failures

Government and Market Failures

It is difficult to understand the government role in correcting the market failures without understanding the market failure concept and its causes. In the economic context, market failure is defined as the inability of the market to achieve its equilibrium. At equilibrium, the product quantity provided by the producers (suppliers) in the market equals the quantity demanded by the buyers (consumers) (Ajefu & Barde, 2015). In modern microeconomics, market failure is defined as a situation in which individual incentives for rational behavior fails to achieve rational outcomes for the large group (Welker, 2009). Defined from the different approach, market failure is a condition where an individual makes the right decision that is deemed appropriate for himself but appears wrong for others (Keech, Munger, & Simon, 2012). The existence of market failures calls for the government to intervene to create an economy characterized by efficient allocation of resources. This paper investigates the appropriate approaches employed by the government to correct market failures.

Causes of Market Failures

As noted above, market failures lead to economic disequilibrium since the quantity supplied is unable to meet the consumers’ demand. This phenomenon is caused by information asymmetries, monopoly privileges, negative externalities, inequality, unstable markets, demerit goods and incomplete markets (Keech, Munger, & Simon, 2012). The information asymmetries occur when the market is unable to provide sufficient information to both parties engaged in the transaction. Secondly, the failure of the market to control monopoly influence makes it hard to maintain market equilibrium. Third, negative externalities affect the parties not involved in the pursuance of the individual’s self-interest. Positive externalities have also been found to cause market failure.  Fourth, it becomes challenging for the market to reduce the income gap, especially in the situation where the market transactions are centered on producers and consumers with high profits and incomes respectively. Fifth, unstable markets make it hard to establish a stable equilibrium. Sixth, at times markets are unable to control certain demerit goods such as alcohol and cigarettes. Finally, the existence of incomplete markets, especially in the healthcare and education sectors shatters market effort to correct the failures (Winston, 2009).

How Government Correct Market Failures

            The government employs the range of interventions to correct market failures. First, through increased tax especially on the goods deemed to contribute to negative externalities, the government increases the price and as a result reduce supply as well as consumption of such goods. Secondly, the government uses subsidization approach to encourage more production and reduced prices to encourage consumers to purchase commodities with positive externalities. Thirdly, the government can enter the market and provide the good perceived to cause market failure. For example, the government directly provide public goods with positive externalities with efforts to remedy the failure. Fourth, the government can engage in buying the buffer stocks whereby it will buy the products at the floor and sell them at the ceiling price (Welker, 2009). Fifth, the government set rules and policies that regulate the manufacturing, sale and consumption certain products, especially the items with negative externalities. Sixth, the government tackle market failures caused by the negative externalities through the issuance of pollution permits that allow firms to produce pollutants to a certain level (Welker, 2009).

Reasons for Government involvement in Market Failures

 The major government objective is to promote economic equality among its citizens. The government will do so by ensuring efficient allocation of resources and equitable distribution of wealth and incomes (Pettinger, 2017). For example, many emerging economies experience wide economic disparities calling for the government to intervene to counteract the failure caused by the inequality. Secondly, it is the responsibility of the make sure its economy remains stable. Therefore, the government will be forced to engage in correcting the market failure to counteract factors such as exchange rate fluctuations, unfavorable balance of payment, inflation, depression, and unemployment. Finally, the government intervenes in correcting market failure to encourage healthy competition, for example, enacting policies and laws that discourage monopoly on certain products.

Based on the course readings, the government relies on Macroeconomic tools to correct the market failures. Macroeconomics investigates the performance, and the behavior of the economy is the whole. Market failure is a microeconomics factor affecting the economy can be examined using macroeconomic tools. Similarly, the government executes role in correcting the market failures by using models provided by macroeconomics to formulate sound economic strategies and policies. Without understanding the macroeconomic concept, it will be hard for the government to correct the failures in the microeconomics factors.The government plays a crucial role in maintaining the stable market. For example, it erects the appropriate strategies to create equilibrium market where the quality demanded equals the quantity supplied. Additionally, the government intervention influences the efficient allocation of resources, and as a result, the citizens’ economic welfare is enhanced. However, there are situations whereby the government intervention strategies may fail to work. For example, it is difficult for the government to correct the market failure caused by public goods due to their non-exclusive and non-rivalry traits that do not permit their existence in the free market. Therefore, the government role in correcting the market failure may not work in all situations.

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