Sam Marson
“Since markets allocate resources to those who value them the most, there is no need
for government to intervene.”
In the western world, the price mechanism plays the largest role in determining how we solve the
economic problem of allocating scarce resources. The free market is viewed by many economists as
the most efficient way of allocating these resources and some such as Thomas Sowell have written
many books advocating for as little government intervention as possible. However, the free market
has shown to result in 3 major market failures (a market failure being where the distribution of
goods is inefficient) which will be explored in the essay. Asymmetric information, public goods and
externalities are the key reasons why the government does need to intervene in the economy.
Asymmetric information is where one party involved in an economic transaction possesses greater
material knowledge than the other party. It is usually that the buyer has less knowledge than the
buyer and so the resource won’t be allocated efficiently. A key aspect in transactions is often the
quality of the good or service being sold. A buyer would not buy a cheap, flimsy good manufactured
in China if he knew it would break after a few days. The seller would be aware of the poor quality
but still sell the good and not provide warranty or returns and so the buyer loses out. This is known
as adverse selection, where one side of the market can’t observe the “type” or quality of the goods
on other side of the market. Another example of asymmetric information is in the insurance market
where a health insurance provider knows less about the health of a person being insured than that
same person who has purchased insurance. The provider also can’t base their rates on the average
incidence of health problems in the population can’t just base their rates on the average incidence
of health problems in the population due to the likelihood that as people with more health problems
are more likely to buy health insurance. Furthermore, there is moral hazard as insurance companies
don’t know how much a person will look after themselves or whatever good they are insuring.
Asymmetric information in markets evidently requires government intervention to stop buyers and
sellers from losing out in various situations where the market is not efficient. For example, the
government can put goods through various tests to move closer to informational symmetry. The
government can also legislate so that sellers have to tell the consumer what ingredients are in food
or what materials are used in a good. Lastly, the government itself has large stores of information
regarding crime and health which could be provided to insurance firms to aid them in determining
their rates.
A second market failure regards public goods. These are goods that are non-excludable and nonrivalrous which means that you cannot stop people from using a good and that its use by one person
doesn’t stop others from using it. An example of a public good is national defence. Everyone in a
country benefits from better national defence as people are safer and more protected from
invasion. However, the free market fails to provide this good as it is not profitable. It can be argued
that it would be provided to some extent as individuals can have motivations other than money, but
most likely national defence would be much weaker when compared to government-run defence.
Government intervention is required with public goods like national defence, street lighting or even
water and air as the free market does not provide these goods to a sufficient quality due to a lack of
profit incentive as non-excludable goods are hard to make money from. The government can instead
use its power to tax citizens and put that money towards funding the provision of public goods like
national defence which it spends over £70 billion on per year. The government also has an incentive
to provide public goods to an acceptable standard as it wished to be re-elected and people value the
running of services like the defence, education, and healthcare.
The third and arguably most important market failure regards externalities. These are the impacts on
third parties when goods and services are bought or sold. In the free market, it is unlikely for the
buyer or seller to take into account anything other than the price and compare it to the willingness
to buy/sell. However, many goods have an impact on society when they are consumed. It is more
common for goods to have negative externalities such as is the case with alcohol. Alcohol
consumption not only has a private cost but a social cost as a person who drinks it can become
violent, disruptive, drink and drive or just drink excessively over time which is more likely to cost the
NHS money on treatment and care. These effects are not taken into account by the free market and
so alcohol is overconsumed when compared to the socially optimum quantity. This market failure to
allocate goods efficiently requires government intervention so that the social cost is taken into
account. This can be done via an alcohol tax, alcohol dangers awareness and in Scotland, there is
even a minimum unit price for alcohol set at 50p. Negative externalities are particularly important at
the moment due to climate change and the social cost of pollutants being very high. The
government is needed to tax carbon and disincentive the production of goods that have negative
effects on the climate.
In conclusion, the government is needed to intervene in the market, particularly to address
externalities such as the harmful effect of goods and services on the environment. Public goods also
need to be run by the government or else they would be provided to a sufficient level. Lastly, the
government is required to ensure that market transactions are fair and that information symmetry is
as high as reasonably possible or else buyers would be taken advantage of.
Bibliography
Core Book (online) https://core-econ.org/the-economy/book/text/0-3-contents.html
Intermediate Microeconomics (9th Edition), Hal R. Varian