Transcript Government failure

Government Failure
A misallocation of resources arising from
government intervention
Government failure
View, post 1945 is that government would correct market
failure
Increasingly clear government intervention may actually make
the problem
So market failure can be replaced by government failure
Why government failure?
1. Political motivation of decision makers
Politicians want re-election - take actions for short-term political advantage
Taxation on petrol - policies to correct market failure only be implemented when
they are likely to win votes
2. Lack of information
Assumption made that governments have the information intervene effectively
Better information than the participants in the market
Suggests govt knows the views of consumers and suppliers better than they do
Decisions based on nationally collected statistics - notoriously unreliable
3. Impact of policy and side effects
Some policy operates with long time lags - fiscal policy
Danger is that by the time it takes effect cycle will have moved
into a new phase
Government failure would occur as a result of market
movement
4. Speed of response
Govt. - bureaucratic in its procedures responses too slow to
deal with changing circumstances rapidly enough
Imposition of a minimum wage
S
Wage per
hour £’s
Minimum wage
3.60
Free market wage - £2.50 per hour
100 workers D & S
2.50
Minimum wage of £3.60
↑ supply 150 but ↓demand to 75
D
75 workers wages ↑ £2.50 to £3.60
0
100
150
75
Quantity of workers D & S
25 workers no longer have jobs as firms no longer require their services
Another 50 workers who would like to work in the firm
Some redundant workers may offer to work for a lower wage
D & S of rented accommodation - equilibrium at price of £300 per month
D = S at 100 properties
Rent £’s
S
Govt. imposes maximum rent at
£120
Supply ↓ 100 to 30, demand ↑ 100
to 200
D > S by 170 units
300
120
Maximum rent
D
:
0
30
100
200
D & S of rented accommodation
Maximum rent stops the price mechanism from automatically adjusting and may
lead to:
Owners evicting tenants - sell their properties rental income has fallen
If unable to evict allow the properties to deteriorate - hope that tenants will leave
Less properties will be available for rent
Criminal elements enter the market
Black market - some properties are available illegally above the minimum price
Policy abandoned - govt. subsidises poor tenants - cannot afford the market rate
Government ↑ building of council or social housing – shift supply curve right
The Health care Market
Price of
healthcare
S
D
Supply perfectly inelastic
NHS supplies at a zero price
Demand OA > Supply OB
P
AB requires additional resources
Rejected option - market to clear at price P
0
A
B
Quantity of healthcare
Diagram shows resources rationed by queuing rather than by price
Health care provided by the market
Price of
healthcare
S
F
S1
A
Eq. at the price OA and quantity OB
E
Merit good ↑ consumption to OC
To consume OC price must ↓fall to OE
To supply OC the price must ↑ to OF
Government subsidy of FE
D
0
C
B
Quantity of healthcare
Price to consumers will be OE where OC can be provided
The effect of the subsidy will be to shift supply from S to S1
Agricultural Markets
Under free market agriculture gives:
Price fluctuations for consumers
Unstable incomes for suppliers
Governments’ use stabilisation/buffer stock programmes
These programmes are applicable to primary products
Aim to reduce fluctuations in output and prices and try to stabilise incomes
Put in place by the producers themselves, or instigated by the government
Buffer stocks
Planned production OA sell at the price OP
Good year output ↑ to OC
Price per
Tonne
S2
S
S1
P1
P
P2
D
0
E
A
Quantity per Tonne
At OP2 farm incomes↓ - authorities purchase AC – keeps price at OP
Bad year output ↓ to OE
To stop price ↑ to OP1 – hits consumers - authorities sell EA – keeps price at OP
C
Seems a simple enough scheme but there are several problems:
Implication for the incomes of the primary producers
Financing buffer stocks - who pays, producers, government, taxpayers
Establishing price - consumers want a low price producers want high price
Problems as technology changes - substitutes developed, demand patterns
change e.g. sugar
Storage costs and perishability - too many years of bumper harvests
Problems of inadequate supplies if there are too many years with a poor harvest
Long term problem - YEOD for many agricultural products is very low
As income ↑ demand ↑ fairly slowly, prices and profits will be depressed
Necessary for resources to move out of these industries
Hastened by ↑ in productivity -better seeds, stronger strains
Governments do not want a depressed agricultural sector
For environmental reasons do not want agricultural land to become industrialised
France does not want a rural way of life to be destroyed
Authorities using "set aside " policies - farmers are being paid to leave their land
fallow and not use it
Taxation
• Indirect tax
– Tax levied on expenditure on goods or
services (as opposed to a direct tax, which is
charged directly to an individual based on a
component of income)
• Incidence of tax
– The way in which the burden of paying a
sales tax is divided between buyers & sellers
Taxation
Demand Elastic
Demand Inelastic
Price
Price
S + tax
S + tax
C
S
S
C
A
A
D
D
0
D
D
0
Quantity
Quantity
Indirect taxes like VAT shift the supply curve to the left
Tax is shown by the vertical distance between the two supply curves – CD
Consumer pays CA – Supplier pays AD
Perfectly Inelastic
Perfectly Elastic
S + tax
D
Price
Price
S + tax
S
S
D
0
0
Quantity
B
Quantity A
D = 0 - price ↑ by the full amount of the tax - all paid by the consumer
Incidence of tax indicated in red
Demand perfectly elastic - price unchanged - quantity supplied falls from OA to OB
Effect of taxation on the size of an industry
Before tax the output is OA
S + tax
Price
Tax shifts the supply curve from S-S1
S
D<1 output falls to OB
D>1 output falls to OC
D>1 consumers buy substitutes:
Leads to a fall in output
Possible ↓ economies of scale
Possible ↓ in the size of the-industry
D>1
D<1
0
C
B
A
Quantity
Revenue Taxes
S + tax
Price
S
B
V
C
Z
A
X
E
D>1
N
D<1
0
Quantity
Govt. tax goods where D <1 -↑ in price means ↑ spending - tax revenue = ABCE
Where D>1 tax take only XVZN which is < ABCE