1.4.2 Government failure

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    a) Understanding of government failure as intervention that results in a net welfare loss
    Government failure – when the costs of intervention by the government to solve market failure outweigh the benefits –net welfare loss
    Happens for two reasons:
    • Government intervention may deepen the existing market failure • Government intervention may lead to a new type of market failure
    b) Causes of government failure:
    c) Government failure in various markets
    Distortion of price signals
    Government subsidies or taxes could distort price signals by distorting the free market economy – could be inefficient allocation of resources because the market mechanism isn’t able to act freely

    Governments can introduce minimum and maximum prices but this can create distortions which lead to:

    Unintended consequences
    When actions of producers and consumers have unexpected consequences
    With government policies, consumers react in unexpected ways – makes government policies expensive to implement
    E.g. if business rates fall:
    • Businesses may close • Higher unemployment • Taxes from businesses decrease so the tax burden is shifted to normal people (E.g. can lead to an increase in taxes like income tax and VAT)
    Examples:
    Plastic bag companies shit down due to 5p charge – because people don’t buy them anymore
    Banning legal highs may drive trade to black market
    Government subsidy cuts may force solar energy companies out of business
    Excessive administrative costs
    Social benefits of a policy might not be worth the financial cost of administering the policy – may cost more than the government anticipated
    E.g. a tax is introduced but the price it takes to administer it may minimise the income of the tax and even exceed the tax
    Information gaps
    Some policies might be decided without perfect information – impractical for governments to gain every bit of information they need as it may require a full cost-benefit analysis which may be time consuming and expensive, so assumptions are made (value judgement)
    The consumer, producer and government have different levels of knowledge
    Examples
    Government may try and regulate the finance sector even though people in the finance sector may know more about the market
    A government may try and influence the education sector and make decisions on schools who know more about the sector
    Electric car subsidies may fail to spark interest in green technology
    Other types of Government failure
    (Tax) Evasion
    E.g. Governments may raise tax on demerit goods – may lead to an increase in attempts at tax avoidance, evasion, smuggling and the development of black markets
    Disincentive effect
    E.g. In order to reduce inequality (one market failure) the government may introduce welfare benefits but this may deter people from working and create another market failure

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