Question

a.List five reasons why the government may want to intervene in markets and provide an example of each.

b. Consider the market for night-time events at Bellerive Oval. To host night-time events the oval must have its large light towers switched on which shine brightly into neighbouring houses disrupting their sleep and night-time recreation

1. What is the externality in this situation and why is it a market failure?

2. Draw a diagram for night-time events at Bellerive Oval. Clearly identify: the private and social costs curves, efficient equilibrium, the market equilibrium and the deadweight loss.

3. How might Coasean Bargaining be used to reduce the deadweight loss?

Answer 1

(a) Reasons of intervening government in market :

• Regulating the Market : There are many complexities in the market which government solves through Monetary and Fiscal Policy. There are the major two policies which have the potential of achieving high economic growth, remove unemployment, reduce inflation, brings interest rate to normal level and many more. Government also regulate economy by solving conflicts which arises between producers of firms, their customers and solving market failures and remove externalities.
• Maintain Pricing : There are many firms which have some sort of market power which they use and raise prices upto that level which leads to raising prices for customers and reduces the welfare in society and increase the dead weight loss. Government here maintain prices for customers so that they can attain the products at minimal prices and if it is not feasible to maintain prices, they also provides subsidies for that.
• Taxes and subsidies : Government levies taxes on individuals and the revenue collected from it is used for welfare improvement of society by building roads, bridges, flyovers, hospital, schools etc. which increases the social welfare and government provides subsidies too when people need them. Likewise in most of the cases they provide subsidies to below poverty line people.
• Equitable Distribution of Income and Wealth : We have a huge income distribution in market where some people are earning in billion-million dollars whereas others even do not have enough money to feed their family. Government imposes progressive taxes on rich people which means tax rises as income rises and try to retain maximum possible tax from them so that they can spend on poor.
• Improvement of the economy : Government of a country is completely liable to improve the performance of the economy. They launch schemes which helps in reducing unemployment, increase literacy rate majorly working on HDI index (Human development index). They helps in earning poor people sufficient income and try to pull them up from misery.

(b) Externality is the situation of costing the whole society by one/some firms and does not reduce the price of that product i.e. there is one firm in the society which through dump in the local river and pollutes the whole water therefore killing the fishes. People in that society are completely dependent on fishes because they sell fishes in the market for feeding their family. Thus that firm is creating externality here and reducing societal welfare.

In this case when stadium lights up in the night, people in the locality gets disturbed which affects their sleep. So it impacts directly the society people and reduces welfare.Cosean Theory describes the economic efficiency in the case of externality. The theorem states that if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property. Once there is Pareto efficient equilibrium, there is no one in the economy whose welfare can be increased by reducing the welfare loss of others. Thus it helps in reducing deadweight loss.