Question

main reasons for why the market might fail. Explain why state intervention is needed in each of these cases of market failure. Give examples of economic policy for correcting market failures. Briefly discuss the pros and cons (advantages and potential problems) of government intervention for attaining allocative efficiency.

Answer 1

There are many reasons as to why market may fall, there might be fall in the expectation of the profitability of the company, there might be widespread expectation of recession, situations like political disturbances, war, terror attacks can also cause the markets to fall. The state intervention is needed in these cases not necessarily directly but a general intervention is important to reassure the market that the government is seriously considering the issue. In case of widespread economic recession expectation, the government can issue stimulus economic package because that will help the economy in getting back on its track and it can help in reviving the economy. In case of political instability, the government can reassure the industry that the rules are not going to change significantly which can affect their operation. In cases of war and terror attacks the government normally chooses to close the stock market until the situation is under control and all the threats have been neutralized. There are different economic policies for dealing with different market scenarios. Let’s say when the market is falling because of one particular sector then that sector can be given tax break or an economic stimulus package can be issued by the government. For example, in 2008 when the banks were facing significant credit issues the federal reserve provided liquidity to the banks. There are certain benefits of government intervention in the market, it can actually put a break on the falling market and it can help in bringing stability in the market. It can also help in reassuring the investor that the government is concerned with the well being of the investor but at the same time if the fundamental of the economy are not strong then the government intervention in the market might not do much to make the situation any better and even if it does then only for a very brief period of time.