Not all the time, market is left on the vagaries of sentiments of surplus seeking consumers and producers. If the volatility breaks the tolerance range, government has to step in to recorrect. As a last resort, it is necessity of government to improve market outcomes. In short, market failures compel government to intervene timely to restore equilibrium. Let’s decode how does government improves market outcomes…
Market failures result when free markets do not allocate resources in the most efficient manner. Understanding these failures is essential to grasp the rationale behind government intervention in the economy. There are several prominent types of market failures, each illustrating unique challenges that necessitate corrective measures by governing authorities.
Why does government intervene in market?
Many a times, commodities do not carry actual cost onto the final consumers. Either negative or positive effect of commodity is indirectly borne by someone else who may not be the part of.
Simply, the extra cost is directly or indirectly borne by the third party in the form of positive or negative externalities. Governments can sometimes improve market outcomes.
In such situation, market fails to allocate given resources efficiently. Therefore, for proper correction, the role of government to improve market outcomes become indispensable.
Invisible hand Vs government interventions
In market economy, there are certain invisible forces that act as an insurance against the any types of market failures and are enough to ensure reasonable functioning equilibrium in market. If the role of invisible hand in market is so effective to allocate resources efficiently, why do we need for interventions by governing authority?
Certainly, there might be some limitations for the so called the idea of invisible hand in maintaining proper functioning. Market failures are the product of mismatch between demand and supply or negative or positive externalities for bystanders. Here, the role of government to improve market outcomes become utmost important.
Role of externalities in functioning of market
Suppose, government is constructing a dam on a particular region to minimise the impact of flood, support growing urban settlements, and generate hydropower. Indirectly, apart from this there, that dam is going to benefit thousands of farmers to irrigate theirs lands by the means of lift irrigation for that they haven’t paid anything. Despite paying anything, the farmers are getting indirect benefits of irrigation is called positive externalities.
In layman’s term, externality is nothing but the negative or positive impact of a thing or actions of a person for bystanders or third party. Externalities can be positive as well as negative depending on actions of the person in question.
For example, pollution created as a by-product by a firm is a negative externalities for the people living in the region is termed as negative externalities. Whereas, the indirect benefits received by the region where quality highway is constructed is classified as positive externalities for third party.
Relations between market power and market failure
In the absence of perfect Market competition and forces the prices of identical products can’t be same due to control of market power by some firms. Whenever a single person or group (monopolistic) possess abilities to affect the outcome of price of given product in the absence of perfect competitive market, it is said that the firm or group has power to influence price or has market power regarding the product in question.
In this scenario, is it possible for market to ensure equilibrium? Definitely, it is hardly possible. So, we can call it inefficient market or market failure. Because, market fails to deliver expected results.
Means and ways of Government Intervention
First, governments often step in to address market failures, which occur when the free market, if left alone, does not allocate resources efficiently. A fundamental concept is Adam Smith’s notion of the “invisible hand,” which suggests that individual self-interest in a competitive market can lead to optimal resource allocation. However, there are instances where this does not occur, requiring government action.
Second, one primary role of government is to regulate industries to prevent monopolies and ensure fair competition. Regulations are designed to uphold market integrity and protect consumers’ rights. For example, antitrust laws can dismantle monopolistic practices and enable new entrants into the market, thereby fostering innovation and competitive pricing.
Third, governments also provide public goods, which are characterized by non-excludability and non-rivalry. Examples of public goods include national defense, public parks, and street lighting.
Fourth, pollution from industrial activities imposes costs on society that are not reflected in market prices. Government policies, such as taxes on carbon emissions or subsidies for clean energy, aim to internalize these externalities, guiding market behavior towards more socially beneficial outcomes.
Fifth, finally, fiscal and monetary policies play a critical role in managing economic stability. Through these tools, government can influence inflation and unemployment rates, promoting a healthy economy that balances the benefits of free markets with necessary regulations.
Examples of successful government interventions
First, public health initiatives aimed at reducing the spread of contagious diseases. During the COVID-19 pandemic. Governments worldwide implemented measures such as vaccination programs, social distancing mandates, and public awareness campaigns to curb and control pandemic.
Second, clean Air Act and the Clean Water Act in the United States have played a crucial role in improving air and water quality. The enforcement of these regulations necessitated compliance from industries, resulting in a gradual reduction of pollutants and long-term enhancements in public health.
Third, antitrust laws provide yet another compelling example of government successes in maintaining market competition. Legislation such as the Sherman Act ensures that monopolistic practices do not undermine fair trade.The idea of invisible hand/Marginal utility and total utility