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Government Intervention Essay

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Discuss the case for and against government intervention in an economy. In most of the countries, the government has intervened in the market system.

To some extent there is a dire need of government intervention in the market system, although there is a debate over this point among the economists. Many economists believe that the role of government intervention improves the market system. The government can easily enforce the rules that can help in the smooth functioning of the market system. On the other hand, there are economists who believe that government interventions in a market system are the reason of inefficiency in the system.

There are some goods that underprovided and underconsumed. Such goods are cold merit goods. They can be defined in terms of their externality effects and also in terms of informational problems facing the consumer. A merit good is a product that society values and judges that everyone should have regardless of whether an individual wants them.

In this sense, the government is acting paternally in providing merit goods and services. They believe that individuals may not act in their own best interest in part because of imperfect information about the benefits that can be derived.

Good examples of merit goods include health services, education, and work training programmes. Why does the government provide merit goods and services? * To encourage consumption so that some of the positive externalities associated with merit goods can be achieved * To overcome the information failures linked to merit goods, not least when the longer-term private benefit of consumption is greater than the shorter-term benefit of consumption * On grounds of equity – because the government believes that consumption should not be based solely on the grounds of ability to pay for a good or service Education is an example of a merit good.

Education should provide a number of external benefits that might not be taken into account by the free market. These include rising incomes and productivity for current and future generations; an increase in the occupational mobility of the labour force which should help to reduce unemployment and therefore reduce welfare spending. However, there are some goods which are thought to be ‘bad’ for you. They are cold demerit goods. Examples include the costs arising from consumption of alcohol, cigarettes and drugs together with the social effects of addiction to gambling. The consumption of demerit goods can lead to negative externalities.

The government seeks to reduce consumption of demerit goods. Consumers may be unaware of the negative externalities that these goods create – they have imperfect information about long-term damage to their own health. The government may decide to intervene in the market for demerit goods and impose taxes on producers and / or consumers. Higher taxes cause prices to rise and should lead to a fall in demand. However high taxes increase unemployment because firms may relocate abroad increases cost of production for firms making the less competitive to firms in another countries where no tax is applied.

But many economists argue that taxation is an ineffective and inequitable way of curbing the consumption of drugs and gambling particularly for those affected by addiction. Banning consumption through regulation may reduce demand, but risks creating secondary (illegal) or underground markets in the product. Market failure with demerit goods – the free market may fail to take into account the negative externalities of consumption because the social cost is less then private cost. Consumers too may experience imperfect information about the long term costs to themselves of consuming products deemed to be demerit goods.

The social optimal level of consumption would be Q3 – the output that takes into account the information failure of consumers and also the negative externalities. One way to solve this problem is to try to remove the information failure. Information deficits can often lead to a misallocation of resources and hence the possibility of market failure. Information failure occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially ‘wrong’ choices.

Government action can have a role in improving information to help consumers and producers value the ‘true’ cost and/or benefit of a good or service. Examples might include: * Compulsory labeling on cigarette packages with health warnings to reduce smoking * Improved nutritional information on foods to counter the risks of growing obesity * Anti speeding television advertising to reduce road accidents and advertising campaigns to raise awareness of the risks of drink-driving * Advertising health screening programmes / information campaigns on the dangers of addiction Another dvantage of government intervention is the national minimum wage.

The national minimum wage was introduced into the UK in 1999. It is an intervention in the labour market designed to increase the pay of lower-paid workers and thereby influence the distribution of income in society. In October 2005, the value of the minimum wage for adults was ? 5. 05 – following a series of small increases over recent years. The main aims of the minimum wage 1. The equity justification: That every job should offer a fair rate of pay commensurate with the skills and experience of an employee 2.

Labour market incentives: The NMW is designed to improve the incentives for people to start looking for work – thereby boosting the economy’s available labour supply 3. Labour market discrimination: The NMW is a tool designed to offset some of the effects of persistent discrimination of many low-paid female workers and younger employees A diagram showing the possible effects of a minimum wage is shown above. The market equilibrium wage for this particular labour market is at W1 (where demand = supply).

If the minimum wage is set at Wmin, there will be an excess supply of labour equal to E3 – E2 because the supply of labour will expand (more workers will be willing and able to offer themselves for work at the higher wage than before) but there is a risk that the demand for workers from employers (businesses) will contract if the minimum wage is introduced. Although all political parties are now committed to keeping the minimum wage, there are still plenty of economists who believe that setting a pay floor represents a distortion to the way the labour market works because it reduces the flexibility of the labour market 1.

Competitiveness and Jobs: Firstly a minimum wage may cost jobs because a rise in labour costs makes it more expensive to employ people and higher labour costs might damage the international competitiveness of British producers. To the extent that rising unemployment worsens the living standards of those affected it has a negative impact on poverty. 2. Effect on relative poverty: Is the minimum wage the most effective policy to reduce relative poverty? There is evidence that it tends to boost the incomes of middle-income households where more than one household member is lready in work whereas the greatest risk of relative poverty is among the unemployed, elderly and single parent families where the parent is not employed.

Government intervenes to stabilise farmer’s income and reduce price fluctuations using buffer stock schemes. The prices of agricultural products tend to fluctuate more violently than the price of manufactured products and services. This is largely due to the volatility in the supply of agricultural products coupled with the fact that demand and supply are price inelastic.

Buffer stock schemes seek to stabilise the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low. The supply curves S1 and S2 represent the supply of wheat at the end of two different seasons. Supply is perfectly inelastic since farmers cannot change the quantity supplied onto the market post harvest. The organisation wishes to keep price fluctuations within a certain band: it will not allow the price of the product to rise above P max or to fall below P min.

Assume that in one particular year there is a bumper harvest so that S1 is supplied onto the market. In absence of any intervention the market price would drop below P min, so the organisation buys up AB of the product to increase the market price up to P min. In the next year bad weather may result in a poor harvest so that only S2 is supplied. The market price would rise above the maximum permitted by the organisation, so the organisation sells CD of its stocks onto the market to reduce the price to P max. In contrast buffer stocks do not often work well in practice.

Perishable items can not be stored for long periods of time and can therefore be immediately ruled out of buffer stock schemes. There are also high administrative and storage costs to be considered. Also education or healh sphere can suffer. The economists have a mixed view about the importance and effects of government intervention in the market system, it can be said that government interventions should aim at working with the market system that is already existing rather than implementing policies that make great changes.

If the government intervention is such that it introduces inefficiencies greater than rationalizing the entire market system, there is a threat of damaging the economy. The distorted government intervention can lead to consumer dissatisfaction and higher costs. Most of the economists are of the view that government interventions should be facilitating in nature rather than having a direct control over the market.

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