Market Failure & Government Intervention
Diagram: Causes of Market Failure
Market failure includes demerit, merit & public goods, abuse of monopoly power, factor immobility & externalities
Explanation of causes of Market Failure and Government Intervention
Cause | Explanation | Government Intervention |
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Demerit goods | These are goods which have harmful impacts on consumers or society as a whole They are often addictive E.g. Gambling, alcohol, drugs, sugary foods and drinks
| They are over-provided in a market and their consumption often creates external costs Governments often have to regulate these goods in such a way that they raise the prices or limit the quantities consumed
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Merit goods | These are goods that are beneficial to society but consumers under-consume them as they do not fully recognise the private or external benefits E.g. Vaccinations, education, electric cars
| They are under-provided in a market, and their consumption generates both private and/or external benefits Governments often have to subsidise these goods in order to lower the price or increase the quantities consumed
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Public goods | Public goods are beneficial to society but would be under-provided by a free market There is little opportunity for sellers to make profits from providing them, as they are non-excludable and non-rivalrous in consumption Good examples include national defence, parks, libraries and lighthouses
| Non-excludability refers to the inability of private firms to exclude certain customers from using their products. In effect, the price mechanism cannot be used to exclude customers, e.g. street lighting Non-rivalry refers to the inability of the product to be used up, so there is no competitive rivalry in consumption to drive up prices and generate profits for firms Therefore, governments will often provide these beneficial goods themselves, and so they are called public goods
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Abuse of monopoly power | The development of monopoly markets is a natural outcome of a market system Firms seek to eliminate competition by buying out competitors and increasing their ownership of factors of production With less competition, firms can raise prices, reduce the choice available to consumers, or limit the supply
| The outcome is that goods and services are purposely under-provided in order to raise prices and profits Governments often intervene to ensure that there is healthy competition in markets and sufficient provision of goods and services
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Factor immobility | Factor immobility occurs when it is difficult for factors of production to move or switch between different uses or locations The two main types of factor immobility are the geographical and occupational immobility of labour
| Factor immobility results an inefficient allocation of resources in a market (usually under-provision) Governments often implement programs to reduce the factor immobility in order to raise production and output E.g. Support relocation of workers when one industry closes down in a particular area
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Externalities | Externalities occur when there is an external cost or benefit on a third party not involved in the economic transaction These impacts can be positive or negative The price mechanism in a free market ignores these externalities If these external costs/benefits were acknowledged, the price and output in the market would be different
| Generally, governments will seek to subsidise products which have positive externalities (or provide the product themselves) Generally, governments will seek to tax products which have negative externalities (or limit their output through regulation)
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