Question

In general, what happens when government intervenes? Is it necessary a bad thing? Make sure you reference justifications for government intervention - e.g., externalities, monopoly power, asymmetric information, and public goods. Define each and elaborate with specific examples.

Answer 1

Government intervention is not necessarily a bad thing. Because it is necessary in correcting market failure situation.Market failure is the situation of instabilities and ineffiiciencies in the economy.The main forms of market failure in which the government intervention is necessary is that:

Externalities,Public Goods provision,Assymetric information and monopoly power.

Externalities are those situation in which a third party gets affected by others production or consumption activity either positively or negatively.Positive externality is the situation in which Marginal Social Benefit exceeds Social Marginal Cost(MSB>MSC). This situation can create market failure as MSC is not equal to MSB.This can be corrected by subsidizing those services by the government . Eg are public parks. Charging of a nominal fees can also do good for this situation. Negative externality happens when MSC exceeds MSB, which affects negatively the third party due to the actions of the first and second party.Example for this is pollution by factories, or from automobiles. The government can correct this situation by taxing the polluters so that the MSC=MSB.The proper enforcement of property rights can also help to tackle out the situation.

Public goods are those goods which have the properties of non-excludability and non-rivalry. This can cause market failure.As the provision of public goods can cause free ridership problem, the government intervention is necessary.As the public goods have the property of non-rivalry and non-excludability, free market operation is not possible, so government should anlyse the correct demand and supply conditions and deal with the public goods provisioning.

Monoploy power or the concentration of power in single hand can create many problems in a welfare state as it creates many market distortions.The needs of the poor people may not get identified properly.It can cause the exploitations of the marginalised sections of the economy and hence widens the inequality.So, proper rules and regulations should be enacted by the government to solve this issue.

Assymetric Information is the situation in which either of the two parties, buyer or seller, have more information than the other party.Here the government has the role to provide accurate and complete the information to the people so that the problem of information assymetry is corrected.Example is that , various government initiatives like Right to Information,various Information Bueros etc. are put for this purpose.

The government intervention is necessarry to correct these situation , but the over involvement of government may cause distortions in the economy as advocated by Adam Smith's Laissez faire policy.