Causes of Market Failure and Government Intervention

Causes of Market Failure / Reasons of   Government's Intervention in 

Market Economy:

The market economic system operates under Price Mechanism. Consumers show their  will or desire to buy a commodity at a given price in order to maximise their utility. On  the other hand, the producers are aimed at maximising their profit for what they  produce. In market economy, there is no justification for state intervention but there are  some reasons that necessitate the government's intervention in the economy as 

discussed below: 

(a) To avoid Monopoly: 

Monopoly is a situation in which one seller rules over the whole industry. The buyers are compelled to purchase commodity at the price fixed by  the monopolist. Therefore, the government interferes for the benefits of the consumers.  The government interferes in pricing of the commodity, and/or encourages new firms to  enter into the market/industry.

(b) To maintain Price Mechanism:

 There may be possibilities of prevailing an unjustified price mechanism even in the presence of perfect competition in the market.  The government can monitor the prices fixed by the market and protect the consumers  from the burden of unjustified prices. 

(c) To meet Externalities: 

Externalities represents those activities that affect others for  better or worse, without those others paying or being compensated for the activity.  Externalities exist when private costs or benefits do not equal social costs or benefits.  There are two major species, i.e., external economy and external diseconomy. In such situation, government intervene the market with its different policies. 

(d) Increasing Social Welfare and Benefits:  

Another strong reason of government's 

intervention in the market economy is the social welfare and benefit. It is one of the 

duties of an elected government to work for the common welfare of the nation; to 

provide social goods and services, like hospitals, education facilities, parks, museums,  water and sewerage, electricity, old age benefits, scholarships, etc; and the protect the  people from the evils of a laissez faire economy. 

(e) To meet Modern Macro-Economic Issues: 

It is the duty of the government to

ensure that the country is in a right direction of economic development. Government 

must ensure controlled inflation, greater employment opportunities, rapid technological  advancement, adequate capital formation, and higher economic growth rate.

Governmental Activities / Actions taken by the Government: 

It is the duty of the government to ensure that the country is in a right direction of economic development. Government  must ensure controlled inflation, greater employment opportunities, rapid technological  advancement, adequate capital formation, and higher economic growth rate.  Intervention of government in the economy takes a number of forms. The government  may undertake the conduct of production, or may influence private economic activity by  subsidies or taxes, or they may exercise direct control over behaviour on the private  sector. Finally, governments may transfer purchasing power from some persons to  others. The government activities can be broadly classified into four groups: 

(a) Allocative Activities: These activities alter the overall mix of gross national product.  The allocative activities arise out of the failure of the market mechanism to adjust the  outputs of various goods in accordance with the preferences of society. The ultimate  goal of the government is to maximise per capita income. 

(b) Efficiency in Resource Utilisation:

(i) Attainment of least cost combinations 

Maximum efficiency in the use of resources  requires the attainment of three conditions: 

(ii) Operation of the firms at the lowest long-run average cost 

(iii) Provision of maximum incentive for developing and introducing new techniques.

While the private sector is presumed to be less deficient, on the whole, in attaining 

optimal efficiency than in attaining optimal allocation of resources, nevertheless in 

several situations governments may be more effective. 

(c) Stabilisation and Growth Activities: are those activities reducing economic 

instability and unemployment and increasing the potential and actual rates of economic growth. 

(d) Distributional Activities:

are those activities altering the pattern of distribution of real income.

   Approaches of Government Actions:

Following are the approaches or tools of government action plan against the 

malfunctions of market economy: 

(a) Governmental Conduct of Production:

Government may also undertake education. In order to adapt the nature and quality of  education to meet community goals, governments produce the services directly,  although allowing private enterprise to provide them as well for persons who prefer the  private product. 

The public goods such as defence, law 

enforcement, etc are supplied by the government, since their inherent character they  cannot be produced and sold on a profit-making basis by private enterprise. 

Government conduct of production may also be undertaken for efficiency reasons - to  avoid collection costs, to obtain advantages of longer-term investments, or to attain  economies of scale. 

(b) The Subsidy Approach: An alternative to governmental production is subsidisation of private producers to induce them to increase output or to undertake investments that they would not otherwise make. Thus private schools could be subsidised to provide  additional education at prices less than those equal to marginal cost. Subsidies might  also be used to increase investment to lessen unemployment or to lower output when  carried beyond the optimal figure. 

(c) The Control Approach: For some purposes, direct control of private sector activity,  with no governmental production except the limited amount involved in administration of  the regulatory rules, is a satisfactory solution. Activity that gives rise to significant  external costs, such as pollution, may be subjected to controls, such as requirements  for adequate waste disposal. Monopoly may be broken up by antitrust laws or  monopoly firms may be subjected to detailed regulation of rates and services. This form  of regulation creates a continuous clash of interest between government and the firms. 

(d) Aggregate Spending: Prevention of unemployment and attainment of the potential  rate of economic growth or prevention of inflation may require fiscal and monetary