Government failure and distortions in markets

Overview

Government failure, unintended consequence of intervention and law of unintended consequences.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   Define government failure.

   Model answer

   Government failure occurs when intervention leaves resources worse allocated than the market would have left them. The costs of the policy exceed its benefits.

2. 2

   Give the main categories of cause of government failure.

   Model answer

   Information failure leaves policymakers unable to value costs and benefits correctly. Unintended consequences, administrative cost and political self-interest are the other main causes.

3. 3

   How does information failure cause government failure?

   Model answer

   A government cannot know the exact size of an external cost or the elasticity of demand. A tax set on a wrong estimate over-corrects or under-corrects the market.

4. 4

   Give an example of an unintended consequence of intervention.

   Model answer

   A high tax on tobacco encourages smuggling and an illegal market. Revenue is lost and the health gain is smaller than planned.

5. 5

   What is the law of unintended consequences?

   Model answer

   The law of unintended consequences states that intervention often produces effects nobody intended. Economic agents change behaviour in response to the policy itself.

6. 6

   How do administrative and enforcement costs cause government failure?

   Model answer

   The design, monitoring and enforcement of a policy use real resources. A scheme whose running costs exceed its welfare gain leaves society worse off.

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