Government Intervention

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Discuss the case for and against government intervention in an economy. In most of the countries, the government has intervened in the market system. To some extent there is a dire need of government intervention in the market system, although there is a debate over this point among the economists. Many economists believe that the role of government intervention improves the market system. The government can easily enforce the rules that can help in the smooth functioning of the market system. On the other hand, there are economists who believe that government interventions in a market system are the reason of inefficiency in the system. There are some goods that underprovided and underconsumed. Such goods are cold merit goods. They can be defined in terms of their externality effects and also in terms of informational problems facing the consumer. A merit good is a product that society values and judges that everyone should have regardless of whether an individual wants them. In this sense, the government is acting paternally in providing merit goods and services. They believe that individuals may not act in their own best interest in part because of imperfect information about the benefits that can be derived. Good examples of merit goods include health services, education, and work training programmes. Why does the government provide merit goods and services?

* To encourage consumption so that some of the positive externalities associated with merit goods can be achieved * To overcome the information failures linked to merit goods, not least when the longer-term private benefit of consumption is greater than the shorter-term benefit of consumption * On grounds of equity – because the government believes that consumption should not be based solely on the grounds of ability to pay for a good or service

Education is an example of a merit good. Education should provide a number of external benefits that might not be taken into account by the free market. These include rising incomes and productivity for current and future generations; an increase in the occupational mobility of the labour force which should help to reduce unemployment and therefore reduce welfare spending. However, there are some goods which are thought to be ‘bad’ for you. They are cold demerit goods. Examples include the costs arising from consumption of alcohol, cigarettes and drugs together with the social effects of addiction to gambling. The consumption of demerit goods can lead to negative externalities. The government seeks to reduce consumption of demerit goods. Consumers may be unaware of the negative externalities that these goods create – they have imperfect information about long-term damage to their own health. The government may decide to intervene in the market for demerit goods and impose taxes on producers and / or consumers. Higher taxes cause prices to rise and should lead to a fall in demand. However high taxes increase unemployment because firms may relocate abroad increases cost of production for firms making the less competitive to firms in another countries where no tax is applied. But many economists argue that taxation is an ineffective and inequitable way of curbing the consumption of drugs and gambling particularly for those affected by addiction. Banning consumption through regulation may reduce demand, but risks creating secondary (illegal) or underground markets in the product.

Market failure with demerit goods – the free market may fail to take into account the negative externalities of consumption because the social cost is less then private cost. Consumers too may experience imperfect information about the long term costs to themselves of consuming products deemed to be demerit goods. The social optimal level of consumption would be Q3 – the output that takes into account the information failure of consumers and also the negative externalities. One way to solve this problem is to try to remove the...
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