Government Failure | A-Level Economics Notes

These revision notes cover everything you need to know about Government Failure for A-Level Economics. They're designed for students studying AQA A-Level Economics, Edexcel A-Level Economics, and Edexcel International A-Level Economics. Written by Jaisul Naik, UCL Economics graduate and A-Level Economics tutor since 2017.

What is government failure?

Government failure occurs when government intervention leads to an outcome that reduces economic welfare even further.

Explain how government intervention can fail due to unintended consequences

Government intervention aiming to reduce a market failure can cause new problems, which can require further intervention, or increase government costs.

Indirect taxes, regulation and minimum prices

Strict regulation, high taxes and minimum prices can often lead to the creation of black markets as it is more expensive or illegal to buy and sell goods and services legally. This can lead to transactions being made under the counter, meaning that over-consumption or over-production still exists. This can also lead to high policing costs.

Subsidies

Subsidising firms despite poor information about their costs may lead to unintended consequences. For example, a firm with monopoly power should be regulated rather than subsidised as there is no incentive for them to reduce prices for customers. It is also likely that they become inefficient since the subsidy covers more of the firm's costs. On the other hand, firms in competitive markets are likely to become dependent on subsidies leading to long-term costs for the government. It may be better for them to understand why supply is low in the first place, or provide information to consumers to encourage them to pay the market price.

Explain how government intervention can fail due to market distortions

A free-market economist would always argue against government intervention as it distorts signals in the market, meaning that the price mechanism cannot work effectively.

Maximum prices

A maximum price causes an expansion in demand but it also causes a contraction in supply, thus causing an excess demand problem, meaning that output falls even lower than it was in the free market, even for merit goods, as there is a lack of incentive for firms to supply the good or service. The government may have to subsidise firms to increase supply at the lower price.

Minimum prices

A minimum price causes a contraction in demand but it also causes an expansion in supply as firms are actually incentivised to increase output despite possible negative externalities. As there is excess supply, scarce resources can be wasted.

Explain how government intervention can fail due to information gaps

Government interventions can be implemented based on poor information about a market, leading to unintended consequences.

Indirect taxes

Indirect taxes are unlikely to be effective if demand is inelastic. For example, the demand for vapes are price inelastic as they are addictive but as they are a relatively new product it might be difficult for the government to calculate its true PED, meaning that the government cannot calculate the exact tax rate needed to reduce quantity to the socially optimal level of output.

Pollution permits

It is difficult for the government to quantify the effects of environmental damage and therefore they may allocate too few or too many pollution permits.

Subsidies

Subsidies are unlikely to be effective if demand is inelastic. For example, the demand for bicycles may be price inelastic as they are a poor substitute to cars for older people. If the government are unable to calculate the exact PED of the good or service, they would not be able to allocate the correct amount to the subsidy, causing the market failure to remain.

Explain how government intervention can fail due to administrative costs

Government interventions can fail if administrative costs related to research, implementation, monitoring, and enforcement are too high.

Indirect taxes

There may be a high cost to the government as they are required to ask a team of staff to research a market and understand the product's price elasticity of demand, so that they can apply an appropriate level of tax to it. Additionally, there is an even higher cost of enforcement as businesses would otherwise be able to evade taxes through cash payments.

Pollution permits

There may be a high cost to the government as they are required to understand the consequences of environmental damage. This is often hard to quantify, even for scientists. Additionally, there is an even higher cost of enforcement as small businesses may be able to avoid declaring their carbon emissions, much like the problem with tax evasion.

Provision of information

There may be a high cost to the government who need to understand behavioural economic concepts to ensure they can change human behaviour through their advertising campaigns. Additionally, there is a cost to design leaflets and record advertisements, which then need to be paid for through tv channels and radio stations.

Summary questions

1. Explain how government intervention can fail due to unintended consequences
2. Explain how government intervention can fail due to market distortions
3. Explain how government intervention can fail due to information gaps
4. Explain how government intervention can fail due to administrative costs

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