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How Government Compensate For Market Failure Essay

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1. Introduction
The market forces of demand and supply lead to equilibrium price and quantity that can be used to allocate sources effectively in many of the markets. At times they fail to deliver the best level of output for society. The government intervenes using various methods to correct market failure. This report details the six different types of market failure which can occur in the UK in addition to critically detailing how the government attempts to correct market failure. 2. Externalities

According to Samuelson (1954) ‘Externalities create a divergence between the private and social costs of production’. Social costs are the production cost of a product or service including third party costs; in the event of a negative externality the social costs are much greater than private costs i.e. pollution. Externalities are external costs and benefits which arise during economic activity but which are not considered by the buyers and sellers involved as they effect third parties only. Ignoring external costs and benefits can lead to the wrong level of output in the market. Negative externalities, occasionally referred to as external costs, are the costs that separate social and private costs. They are the costs paid for by third parties, which is usually society as a whole. If negative externalities are left to the market mechanism it could lead to over production. Chivian and Bernstein (2008) concluded, ‘soft drinks in large quantities are unhealthy and could lead to medical problems’. This would increase the medical costs for the government, to tackle this issue they could tax soft drinks to discourage use in addition to elevating such charges from healthy drinks consequently providing a cheaper and healthier alternative. Consumers can create externalities by consuming certain goods or services. • Pollution from privately owned cars or taxis

• Public damage caused by alcohol abuse
• Litter on streets
The UK government address these negative externalities through two primary functions; legislations and taxations. Pressure from environmentalist along with studies confirming the existence of global warming forced the UK government to introduce ‘Green taxation’. This includes an increase in petrol prices to discourage use of fuel reliant cars, increase in excise duty on alcohol as well as fines for perpetrators caught in the act of littering. Indirect taxes are used as a means of deterrence on products which could lead to market failure. They differ to specific taxes such as excise duty on tobacco as they are not fixed sum per unit. VAT is an indirect tax which raises cost of production. A pecuniary externality is a type of negative externality which relates to the economic activities rather than physical resources. Apple increased its market share from 25% to 36% in the mobile phone market while others have lost theirs; those suffering losses have incurred a pecuniary externality (Apple iphone market share, 2011). The key difference between pecuniary and real externality is while real externality ought to require compensation pecuniary should not. Positive externalities, if left to market mechanism, could under produce and would not reach level of output which is socially efficient. • Education system, government provides student finance to encourage higher education • Health service, government provides free health service By investing ...

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