Government Intervention on Market Failure

Market failure is when goods and services are not allocated efficiently and could happen in a number of different ways. A few examples of market failure that I would show today would be when there is too much negative externality and demerit goods, and too little positive externalities and merit goods.

Negative Externality & Positive Externality

Negative externality is when a third-party is negativity effected from the business activities. Like for example, pollution from a factory.

Positive externality is when a third-party is positively effected from the business activities. Like for example, preventing illnesses to spread as people have taken immunization shots.

This can usually cause in either an increase or decrease in the production of the type of good or service as externalities are usually not taken into account by the cost benefit analysis.


Merit Goods & Demerit Goods

A merit good is a type of good or service that is considered good as it causes positive effects for the consumers.

A demerit good is a type of good or service that is considered bad as it causes negative effects on the consumers.

Most of the time, demerit goods causes negative externalities. The reason to this is that most people do not know that demerit goods will cause negative effects to them. Due to this, demerit goods, which are desirable, will increase in supply as demand for these types of goods increase. Prices would still stay low as negative and positive externalities are not taken into account. Like for example, cigarettes were desired by most people in the past. Prices for a pack were very cheep and people back then did not know the harmful effects, in other words negative externalities, that smoking a cigarette could cause. Thus, a failure in the market.

On the other hand, merit goods cause positive externalities. However, without the positive externalities taken in to account, merit goods are usually under supplied. Added to this, people also so not have enough information stating that merit goods, such as vaccines, would be beneficial for them. this will lead to a low demand for the said merit good and therefore would also be supplied less. Thus again, a failure in the market.

Government Intervention

So how does the Government fix this market failure?

For demerit goods, the government usually controls its demand and supply. They do this by putting taxes, quotas, and rules and regulations. An example of this could be seen in Singapore. The government has put a 69% tax rate on cigarettes and the results were that consumption of cigarettes, which is a demerit good, has decreased.

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By doing this, it also tackles another market failure, negative externalities. With demerit goods controlled, the negative externalities that is caused by the production and/or consumption of it would also be controlled. In this case, more people would be healthier as they are away from the negative effects that cigarettes can cause such as cancer.

For merit goods, governments would provide subsidies, impose laws and promote the positive externalities that could come from merit goods. An example for this is that in Singapore, certain types of vaccinations are mandatory for children. By doing this, people would be less prone on getting infected by diseases from their friends and family. this will thus cause a decrease in general on the amount of people who are sick and unhealthy.

However, some merit goods are hard to provide as externalities are now included in the costs. for demerit goods, this is a good thing as with higher prices, people are discouraged to buy the expensive good, and thus demand will fall and the demand for it will be controlled. For merit goods however, people would need to be encouraged to buy them. so the government can intervene buy providing subsides to merit goods.


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