Government Intervention In The Market

Content

• Market failure and government failure• Competition policy• Public ownership, privatisation, regulation and deregulation

of markets• Notions of equity• The problem of poverty• Government policies to alleviate poverty and to influence

the distribution of income and wealth• Cost Benefit Analysis

Market Failure

• Markets fail for a number of reasons:– Externalities (social costs and social benefits)– Monopolies– Imperfect information – Factor immobility– Due to equity issues – where there is a disparity

between resource allocation

Government Failure

• This occurs when government interventions either increase the severity of market failure or cause a new failure to arise

• This occurs when policies:– Have damaging long term consequences– Are ineffective – Cause more problems than solve problems

Methods of Government Intervention

• Taxation• Subsidies• Buffer Stocks• Pollution permits• State provision• Regulation• Extending property rights

Extending Property Rights

• Extending property rights is a method the government can use of internalizing the externality.

• The aim of extending property rights is to reduce the impact of the externality

Advantages and Disadvantages of Extending Property Rights

• Advantages • The government doesn’t have

to assess the value of property as the owners are in a better position to do this

• There will be a direct transfer of resources from the polluters to those who suffer – the firms who pollute will have to bear the negative effects

• Disadvantages: • It can be difficult - governments

may not have the ability to extend property rights especially overseas

• Extending property rights within a country can be difficult if the link between the pollution and the problem is unclear

• Its often difficult for the owner of the property to assess its value to them

Causes of market failure

• Inadequate information this may result from:– Not doing a cost benefit analysis– Insufficient information on long term costs / benefits

• Conflicting objectives:– Governments tend to think in the short term rather than the long

term therefore fail to consider long term costs / benefits– If governments control an industry they may be more concerned

with their interests than those of the public– If the policy interventions lead to negative consequences for

consumers / producers e.g. higher income tax

Causes of market failure

• Administration costs – these may be too high to reap the benefits of the intervention

• Political self interest – politicians may do what is best for them thereby resulting in inefficient resource allocations

Regulatory Capture

• Regulatory capture this is where a government regulatory agency who are meant to be acting in the public interest instead becomes dominated by the interests of the existing firms in the industry it is meant to be overseeing

• Regulatory capture arises from the fact that the current firms have a stake in the outcomes of political decisions therefore ensuring they find a way to influence decision makers

Market Failure And Government Failure

• The marginalist model of externalities is used to explain why externalities result in a misallocation of resources

• This model looks at marginal social costs and social benefits to enable resource allocation to be efficient

• By looking at marginal social costs and benefits the government can decide how to impact supply and demand for a specific product decreasing the marginal benefits

.

Government policy and the environment

• Environmental change impacts economic behavior • There is increasing pressure on the government to

consider environmental factors• The environment is often damaged by negative

externalities caused by consumption and production

Competition Policy

• EU and UK competition policies have the following aims:– To increase consumer choice– To ensure effective price competition between firms– To help ignite technological innovations – To investigate anti competitive behaviour which can

have a negative impact on consumers

Competition Policy

• In the UK competition policy looks at:– Control of mergers and takeovers– The issues of antitrust and cartel formation– Market liberalisation – State aid control

Competition Policy - Office of fair trading

• The office of fair trading (OFT) ensures that consumers are getting the right prices for products

• This is to monitor anti-business practices and consumers are protected.

Monopolies and merger competition (M.M.C) and the competition commission

• If the OFT has reasonable intelligence to find that a business is being anti-competitive (e.g. charging high prices or restricting consumer choices), the OFT will report those businesses to the Monopolies and merger competition (M.M.C) or the competition commission.

• MMC investigate if businesses will create unfair competition by taking over companies.

• Competition commission will investigate if businesses are acting unethically such as charging high prices.

Punishment

• The OFT, MMC and the competition commission are likely to investigate businesses with a market share of over 25%.

• If businesses are found guilty of anti-competitive behaviour they can be:

• Fined 25% of all profits being made.• Of they have to give their market share to other

businesses that were affected.

EU Competition Policy• EU competition policy looks at

– Restrictive practices– Abuse of dominant market power.

• This legislation deals with anti competitive behavior• The EU has the power to punish anti competitive behavior even if

there is no formal agreement to act in an anti competitive manner• Penalties include them taking 10% of the firms turnover• Some behaviors including market sharing and exclusive marketing

can be exempt if they increase either consumer benefits or technical progress

Competition Policy - Costs and Benefits of Policies

Costs• Administration costs in

implementing the policy • Can be expensive and

time consuming to enforce

Benefits• Protects consumers from

unfair practices• Encourages and enhances

fair competition

Competition Policy – Real World Examples

• The takeover of Safeway by Morrisons was investigated to ensure that no unlawful practices occurred

• Tesco is currently being investigated by the EU

Public Ownership

• Public Ownership – this is where the government own businesses

• There are arguments for public ownership which include if goods are seen as public goods then the most efficient way for resources to be allocated may be through the market

• If externalities exist in the market the government may choose to provide the goods for consumers e.g. education, healthcare

Public Goods

• These are services that are provided by the government• Pure public goods have the following characteristics:

– Non excludability – everyone can consume the goods whether they pay or not

– Non rivalry in consumption – consumption by one person doesn’t reduce consumption for others

• Examples – street lighting, national defence

Advantages and Disadvantages of Public Ownership

Advantages• Provides jobs which are usually

protected so reduces unemployment

• Finite resources such as water and energy can be guaranteed and controlled

• Able to provide essential services to the whole country

Disadvantages• Higher costs for the

government which means higher taxes

• Inefficiency – public organisations are often inefficient due to diseconomies of scale

• Government and political interference may reduce efficiency of operations

Privatization of Markets

• Privatization occurs when organizations that are owned by the public are transferred to private individuals

• During the 1980s there was intense privatisation of companies in the UK including: British Airways, British Gas and British Petroleum

• When businesses are privatised it allows for increased competition therefore monopoly power can be removed

Privatization of Markets – Advantages and Disadvantages

Advantages• Provides revenue for the

government • Reduces trade union power• Can increase investment as

businesses can use capital from sale of shares

• More incentives to increase efficiency therefore economic welfare is increased

• More competition brings more choice for the subject

Disadvantages• Unemployment may result as

businesses try and reduce costs

• Monopoly power may still exist • Private sector may fail to

allocate resources according to social costs and benefits

Regulation of markets

• Regulation is the control of the market through rules • Many privatised companies are regulated by

watchdogs e.g. Ofcom and BT• Regulators ensure that the new companies don’t

exploit their monopoly power and try and simulate competition allowing the companies to have a smooth transition into the private sector

• They become involved in activities such as price capping

Deregulation of the markets

• This is the act of removing rules and restrictions in the market

• The aim of deregulation is to open up the market and increase competition

• Deregulation aims to increase contestability of markets• Those in favour of deregulation argue it results in lower

prices for consumers, increases investment and in the long term can lead to increased economic growth

Notions of equity

• Equity is a notion of the fairness or justice• Equality is a notion that everything should be the

same • People can have different views regarding what

they view as fair • Differences in peoples views influence policy

Horizontal and Vertical Equity

• Horizontal equity states that people with a similar ability to pay taxes should pay the same or similar amounts.

• This relates to the concept of tax neutrality.• Vertical equity states that people with a greater

ability to pay taxes should pay more.

The problem of poverty

• Poverty can be measured in two ways:• Absolute poverty – this looks at the amount of

people who live below a certain level of income • Relative poverty – this looks at the extent to which a

households income is less than the average income in the UK

• Relative poverty measures allow us to look at inequalities in incomes and wealth

Government Policies to Alleviate Poverty and toInfluence the Distribution of Income and Wealth

• The government try and alleviate poverty and create a more even distribution of income and wealth

• Policies that they use include:– Working credit and tax credit schemes to encourage low-income

households to work– National minimum wage legislation– Schemes encouraging long term unemployed to work e.g. new

deal– Minimum guaranteed incomes for pensioners– Progressive tax – pay more they more you earn and tax free

allowances– Benefits

Working credit and tax credit

• Working credit and tax credit schemes aim to encourage people to go to work on a full or part time basis

• These schemes allow lower income families to gain more income from working than under previous schemes

National Minimum Wage

• This legislation has meant that the lowest paid workers have a guaranteed wage level

• This can lead to increases in absolute poverty

Schemes Encouraging Long Term Unemployed To Work

• These schemes are part of a long term strategy to decrease unemployment levels

• If people work they will be better off then if they claim benefits

• It is better for the government to have lower levels of unemployment as it means they don’t have to pay out for unemployment benefits and they gain revenue through taxation

Minimum guaranteed income schemes for pensioners

• Pensioners are one of the groups of the population most affected by poverty

• In the UK the current % of pensioners living in poverty is 17%

• This figure has fallen and this is can partly be attributed to the pension credit scheme

Progressive Taxation

• In the UK a progressive taxation is operated by the government

• Progressive taxation means that at higher salary levels you pay more

• There is a tax free amount that all people receive and the rate of tax increases as salary increases

Benefits• People who are unemployed, on low incomes or disabled

can claim benefits• Unemployed people can claim unemployment benefits to

cover living costs • Benefits are paid to people for the following:

– Health care– Education– Travel– Housing– School meals and welfare

Policies and Poverty Reduction

• In the past 10 years poverty levels have not been reduced in the UK

• The main reason why poverty has not been reduced is that benefits have not risen at the same price as wage levels so income inequality has risen

Effective Ways to Decrease Poverty

• The most effective ways to reduce poverty include:– Increasing the progressiveness of the tax system so it is

more equitable– Use wage inflation as a basis for increasing the value of

benefits and tax credits– Investment in training to reduce unemployment– Look at indirect taxation and its effects on incomes

Cost benefit analysis

• Cost benefit analysis looks at social benefits and social costs

• Cost benefit analysis involves a number of steps:– Project appraisal– Look at the value of social costs and benefits– Make an adjustment for time – discount future values so

you can look at them at the current rate – Compare social costs and benefits – Look at net rate of return for each project

Advantages and Disadvantages of Cost Benefit Analysis

Advantages• Allows for efficient

allocation of resources• Decreases negative

externalities

Disadvantages• Can be hard to put values

to social costs and benefits• Can be difficult to include

all externalities• Costs and benefits can be

different for different groups

Summary• Market failure occurs when resources are not allocated efficiently e.g. in

monopolies or where externalities exist• Governments aim to reduce market failure with subsidies, taxation, regulation etc• Intervention may increase or create market failure• Competition policy aims to reduce unfair competition and monopoly power • Public ownership is the ownership of businesses by the government• Privatisation occurs when public firms are sold to private individuals• Regulation is rules and restrictions imposed by the government on the market ,

deregulation is the removing of those regulations • Equity is the idea of fairness• Poverty is a problem for UK governments and they try and alleviate it with a

number of policies including benefits, taxation, credits and minimum wages• Cost benefit analysis aims to give values to social costs and benefits thereby

resulting in more efficient allocation of resources