Why is Government Intervention Needed?
- In a market failure, the market fails to achieve allocative efficiency and maximum community surplus.
- Government intervention aims to correct this by shifting MPC or MSC curves to match the MSB and MSC curves respectively.
Negative Externalities of Production
- The production of a good or service generates a negative effect on a third party or on society as a whole.
- The goal of the government is to limit or decrease the production in the case of negative externalities of production.
Legislation
- Governments can pass laws regarding environmental standards that firms must comply with.
- For example machinery upgrades, air filters, disposal requirements
Pros: Easy to apply
Can have a big impact
Cons: Cost of production increases
possibly leading to unemployment and the costs of enforcing policies
Legislations might be ineffective
Legislations might be too harsh or not harsh enough
Legislations make it more difficult for local firms to compete with competitors who don't have the same legislations to abide by
Carbon Tax
- Impose a tax on the firm per unit of output produced. In cases for production of carbon dioxide which harms the environment.
Pros: Government revenue, easy to apply.
Cons: Difficult to measure, difficult to calculate tax
Tradable Emission Permits
- Permission to pollute permits that enforce a quota of emissions. An eco-friendly firm can sell its permit for profit.
Pros: Encourages firms to lower cost, free market sets price of a permit, cooperation among businesses
Cons: Difficult to set an acceptable level of pollution, difficult to measure pollution
Incorrect adjustment of permits can lead to adverse effects. If too harsh it might be damaging to the economy but if it is too relaxed then it will have little to no effect
Positive Externalities of Production
- The production of a good or service generates a positive effect on a third party or on society as a whole.
- The goal is to increase the production for the benefit of society.
Subsidizing Firms
- The government supports beneficial firms by funding them.
Pros: Encourages promotion of the industry and lowers costs for firms.
Cons: The opportunity cost of using government funds (may have to give up other things such as healthcare). Risk of reducing competition in the market.
Direct Government Provision
- The government produces the beneficial goods themselves.
Pros: Government is in full control
Cons: High costs and opportunity cost, lack of expertise by the government, private firms discouraged from joining market.
Negative Externalities of Consumption
- The consumption of a good or service generates a negative effect on a third party or on society as a whole.
Indirect Taxes
- Taxes are designed to correct negative externalities called Pigouvian Taxes.
Pros: Increases the cost of the good quickly, provides government revenue.
Cons: Addictive goods are demand price inelastic which cause small decreases in demand, creation of black markets. Indirect taxes are regressive.
Regulations or Bans
- A regulation or full ban to make the product illegal (such as non-smoking areas).
Pros: Reduce demand, low cost.
Cons: Slow to implement, government spending, enforcing regulations, backlash from consumers regarding free-will, potential rise of black markets (especially prevalent in drug bans)
Negative Advertising
- Government could fund negative advertising such as images on packs of cigarettes.
Pros: Aims to reduce demand naturally.
Cons: High cost and opportunity costs for the government, studies are unclear on how effective advertising is especially on young adults and teenagers.
Positive Externalities of Consumption
- The consumption of a good or service generates a positive effect on a third party or on society as a whole.
- The benefit to society is larger than the price, thus the government tries to increase production.
Subsidizing Firms
- The government funds firms producing the targeted good.
- The increased supply leads to reduced price.
Pros: Encourages promotion of the industry and lowers costs for firms.
Cons: The opportunity cost of using government funds (may have to give up other things such as healthcare). Risk of reducing competition in the market.
Direct Government Provision
- The government produces the beneficial goods themselves.
- The increased supply leads to reduced price.
Pros: Government is in full control
Cons: high costs and opportunity cost, lack of expertise by the government, private firms discouraged from joining market.
Positive Advertisements and Public Awareness Campaigns
Pros: Aim to increase demand naturally.
Cons: High costs and opportunity costs, might be ineffective towards certain populations, lots of research required
Compulsory Regulation
- People are forced to consume the good
Pros: Shifts demand effectively
Cons: government must provide for free, anger from residents, cost of enforcing law