Question

1. In general, what are some of the tactics the government uses to correct market failures? List 3 and provide a brief explanation of the opportunity costs involved in correcting these failures.

2. Briefly discuss the key difference(s) between Keynesian Economics and Neoclassical Economics.

Answer 1

1. Three most popular market failures and the steps taken by the government to correct them are as follows -

Monopolies: Monopolies occur when one prominent firm (or in the real world scenario, few large firms) control the entire market for a particular good or service. When this happens, it is possible for these few firms to charge prices that are higher than their average costs, and hence are able to appropriate a large profit from their market operations. This means that the consumer surplus is reduced greatly, and hence the consumers end up paying mch more for their good or service that they demand as compared to what they would have paid had the market set up been that of a perfect competition. To control this, the government of many countries have the monopoly restricted trade practices acts (MRTP acts) which have laws that specifically hinder the profit making motive of monopolies. For this, the government sometimes puts price caps such that these monopolies are not allowed to charge beyond a specific price, breaks up cartels or huge monopolies, prevents mergers and acquisitions that threaten the competitive spirit of the market, or sometimes it even takes up the reigns of the company in its own hands, i.e. government ownership.

Information Assymetry: Information assymetry is a specific condition in the market that allows one party in the transaction to take advantage of another party because the latter does not have the necesary information that is required for the transaction to be equally beneficial for both the parties. This happens in the every day market, for instance when the sellers hide information about any defects in the marketed product, or adulterated food products that are not properly labelled. This usually affects the consumers more than the sellers in the market. To control this kind of market imperfection, the government has several provisions, like setting up grading and inspection units for food products and in general providing education and training for people to make them more aware of the markets.

Externalities: A third type of market failure is externalities. This happens when a certain transaction affects people other than the two parties involved in the transaction. This means some third party is negatively (or positively) affected by the transaction. For instance, the smoke released form a factory. This will cause a negative externality for the people living near the factory. The factory owner will not necessarily take into consideration this effect while deciding his optimal level of output. The government has to this step is to be able to stop (or lower) the level of production by the factory. To do this, the government will have to tax the factory output or profits, or impose something like a carbon tax has to be implied.

The opportunity costs involved in the correction of these market failures are very easy to understand. All the methods of correction of market failures explained above involve a lot of resources to be devoted in these methods which, if not for this ourpose, would be available for some other purpose, for instance the removal of income inequality and poverty. The cost of monitoring these failures to be able to impose the penalty on violation involves a lot of monitoring and enforcement costs on the part of the government. These imvole resources which can be otherwise used for other constructive projects of the government.