Question

State and explain three reasons for potential government intervention in cases of market failure government intervention – provide an example for each of the three reasons you identify

Answer 1

The three possible market failures and government intervention are:

• Public goods: Because private of public goods is not sufficient as well as efficient government has to intervene and provide the public goods. For example, education, national defense which in case are left on private firms, will always be undersupplied
• Common property resources: As against public goods, here lack of well defined property rights encourages too much exploitation and this causes the resources to deplete quickly. Government needs to intervene and establish property rights. For example, fisheries where no fisherman has a property right over a water body so every fisherman generally overfishes
• Externality: In cases of negative externality, the marginal external cost is imposed on society and is not internalized by the creater of externality which failes the market to generate efficient outcome. By imposing taxes, the outcome can be correct. For example, pollution is created and too much production is done because unregulated markets have no incentive to internalize the cost.