Question

Government intervention to provide public goods is widely rationalized by the failure of the market mechanism to efficiently allocate resources. Discuss the above statement in the light of the different classes of market failure that arise in actual economies.

Answer 1

In the case of externalities, one agent’s activity creates a cost or benefit on others without making a compensation for it nor being paid for it. In such cases, particularly in case of negative externalities the market tends to over produce as private agents maximise their profits by equalizing marginal private benefits and marginal private cost. They ignore the damages being caused and thus there is excess production of externalities. In such situations government needs to intervene to reduce the externalities by using instruments like tax, subsidy etc.

In case of positive externalities there is under production of the good as private agents donot consider the social benefit. This induces the government to intervene and increase the production of such goods and services by providing subsidies and other incentives.

Similarly, there is market failure in case of public goods where individuals may not be willing to pay for the good and would rather free ride. Such goods are essential for the society and the private individuals may not provide such goods or may provide in lesser quantity. Hence government intervention is required.