Microeconomics: Government Intervention and Failure - Essay Example

Microeconomics: Government Intervention and Failure Outline Scarce resources where there exists a free economic system are allocated using price mechanisms. In this case, consumer spending decisions and preferences, as well as business decisions on supply, combine in the determination of equilibrium prices. In a free market, price signals are the most important factors; high demand increases profit potential for those supplying products to the market, which, in turn, causes supply expansion in order to meet consumer demand (Besanko et al 169). This mechanism of free markets is a powerful device in the determination of the manner in which recourses will be allocated among various competitors. Governments, however, could elect to intervene in mechanisms of price where they seek to alter resource allocation, while achieving what they feel will be an improvement in welfare, both socially and economically. Governments everywhere will seek to intervene in free market economies in order to influence how scarce resources are allocated between competing uses (Besanko et al 169). Governments intervene for various reasons, including for the correction of failures in the market, achieving increased wealth, income distribution equitability, and improving economy performance. Governments can intervene in markets in various ways, including regulation and legislation, direct goods and services provision by the state, intervention in fiscal policy, and closing the information gap. However, government intervention could lead to unintended results, referred to as government failure, such as economic crowding out. Government Intervention Options Governments can intervene through institution of regulations and legislation. This occurs through laws passed by Congress, for instance, banning of tobacco in public spaces or banning sale of alcohol to those under the age of 16. For instance, the government uses competition policy laws to check cartels, which seek to fix prices, as well as other anti-competitive practices in the free markets (Besanko et al 178). Another form of law, employment laws, are also used to offer employees legal protection, for example, by setting the maximum number of hours they can work or by setting minimum wages to give the labor market price floor. Today, the amount of legislation and regulation governing economies is increasing. Regulators appointed by the government are also enabled to control the prices of major utilities like infrastructure, gas and oil, electricity, postal services, and telecommunications (Besanko et al 178). Governments may also use regulation in order to infuse the market with fresh competition. For instance, the government could disband a service provider’s existing monopoly as happened with British Telecom. This practice is also referred to as liberalization of the market. However, economists who support free markets have criticized government regulation. They claim that it adds onto business costs, especially due to increased “red tape” that makes businesses uncompetitive. Governments could also choose to provide directly services and goods to its people. Due to increasing privatization of most economic sectors, the state-controlled by the economic sectors have shrunk in the last 20 years (Besanko et al 179). Funding by the state has been used in the provision of public goods and merit products to the population directly, for example, the ObamaCare healthcare plan, which seeks to pay firms in the private sector to provide healthcare to patients. In this case, this is meant to reduce waiting time and lists. Other examples include the government paying private firms to maintain and rehabilitate the road network, as well as to operate penitentiaries and prisons. The government also intervenes through changes to fiscal policy. This is especially used to change the demand levels for specific services and goods, while also allowing the government to pattern the economy’s demands how they want it. One way to do this is through indirect taxes, which are used to increase the price of services and goods that are de-merited, usually resulting in negative externalities due to a hike in the consumption opportunity cost (Besanko et al 180). This eventually reduces the consumer’s demand for those products to a level that is socially optimal. On the other hand, the government could implement subsidies that lower consumer prices for goods that they merit. Subsidies are meant to increase product output and consumption, resulting in positive externalities. Therefore, an increase in supply of the product to the market increases, which, in turn, lowers the equilibrium price. The government may also intervene fiscally through tax relief, which refers to the provision of tax credits to stimulate R&D or corporate tax reduction, which results in stimulation of employment and capital investment (Besanko et al 1180). Finally, the use of welfare payments and taxation interventions are also used in the influence of overall wealth and income distribution. Increased direct taxes on the wealthy or increased welfare benefits are examples of this type of government fiscal policy interventions in welfare and tax payments. The government also intervenes to close information gaps. The government could seek to correct market failures resulting from poor access to information about market-available product benefits and costs. Action in this case play a role by aiding producers and consumers to access information that improves their valuation of true benefits and costs (Besanko et al 181). For example, they could insist on compulsory labeling practices that inform the consumer on the health hazards of particular products, improving information on food nutritional value to counter unhealthy eating, use of health program advertisements that touch on health issues like addiction, and advertising aimed at reducing speeding and drunk driving to reduce road carnage. These particular interventions are not instituted with the aim of altering market prices but, rather, to alter the perceived product benefits and costs of consumer consumption. By influencing demand for these products and behaviors, they seek to influence consumption and output in the long term (Besanko et al 182). The effects of this intervention strategy are difficult to identify, however, and can only be quantified in the long run. Impact of Intervention by the Government It is vital to note that government intervention never results in neutral outcomes and are not driven by neutral assumptions. Government intervention results in economic winners and losers as the government preferentially treats one set of producers or consumers over the other. In addition, the interventions occasionally fail to work in the manner intended by the government, as well as the way economic theory predicts it will. The law of unintended consequences is one of microeconomics’ most interesting areas. Various government intervention policies are affected by external events, while businesses and consumers do not normally behave as expected by the government (Winston 22). This scenario leads to government failure. Government Failure Also referred to as non-market failure, government failure occurs when intervention by the government leads to increased inefficiency in resource and goods allocation, often more than would have happened is they had not intervened. Failure by the government to intervene in failures to the market could lead to an output mix that is preferable socially is defined as passive failure of the government (Winston 25). Corresponding distortions of the economy give rise to diverse forms of government failures, the same as with failures of the market. Government failure in relation to intervention is supported by the argument that intervention by the government, even where markets are deficient in perfect competition’s standard conditions needed for an optimal social environment, it may end up worsening the situation, rather than alleviating it. Government failure, however, just as in market failure, does not indicate a failure to institute a favored solution, but it indicates a problem stopping the efficient operation of markets (Winston 25). Government failure could occur on the side of supply and that of demand. Failures on the supply side are mainly due to principal agent problems, while those on the demand side may involve illogic of collective behavior and problems with preference-revelation. Government failure could lead to economic crowding out, which happens when there is an increase in government borrowing. Borrowing that is aimed at financing government expenditure increases, as well as tax cuts that are more than revenue, leading to private investors being crowded out due to the increase in interest rates (Winston 26). Increase in government spending also results in private investment and spending being crowded out. There are also regulatory government failures that result from legislation and regulation instituted by the government. Regulatory risk results when firms in the private sector face risks due to changes in the regulation that could affect their businesses negatively. Regulatory capture results from regulatory agencies being co-opted by the industry players in the sectors they are meant to regulate. Various mechanisms allow this relationship to grow, including rational ignorance and rent seeking. Finally, through regulatory arbitrage, regulated institutions could exploit the advantages brought about by differences between the position of the regulation and its economic risk (Winston 22). Even where there are stable economies with high income, robust transparency, law mechanisms, and freedom of the press, most increases in the size of government almost always leads to increased public graft. Conclusion In evaluating the effects of the intervention by the government against possibilities of government failure, its efficiency should be considered. Government intervention should lead to improved use of resources that are scarce among various competing entities. It should improve dynamic, productive, and allocation efficiency. The policy should also be effective with the government required to pick the best policy that meets its objectives both social and economic. These would include the policies that are best suited to, for example, check obesity or road accidents, as well as the policies that are most effective in reducing or preventing the monopoly power of cartels or damage to welfare of consumers. The intervention should also have equity effects by being as fair as it can, despite leading to one group in society gaining more than another group. Examples include whether equity effects are increased by intervening to offer maintenance allowances for high school students from poor families, as well as whether increasing income tax rates in a bid to make income distribution more equal, leads to desired equity effects. Finally, the policy must be sustainable enough to help even future generations rather than curtailing their ability to be economically engaged. There should be some level of equity between generations, for example, when it comes to energy policy. Works Cited Besanko, David. Braeutigam, Ronald. R. & Michael, Gibbs. Microeconomics, Hoboken, NJ: John Wiley, 2011. Print. Winston, Clifford. Government Failure versus Market Failure: Microeconomics Policy Research and Government Performance. Washington, D.C: AEI-Brookings Joint Center for Regulatory Studies, 2006. Print. Read More