Y12 Booklet 3: Government Failure

Question 1

When does Government Failure occur?

Answer 1

When government intervention causes misallocation of resources, resulting in a net loss of welfare

Question 2

When is there a net loss of welfare?

Answer 2

When MSC of intervention > MSB of intervention

Question 3

What are the causes of Government Failure? (5)

Answer 3

Distortion of Price Signals;
Information Gaps;
Conflicting Objectives;
Excessive Administrative Costs;
Unintended Consequences

Question 4

What is Distortion of Price Signals? Example?

Answer 4

When government intervention causes prices (and therefore their effects as signals on economic agents) to change

E.g. guaranteed income for farmers allows inefficient farms to stay in business, overallocation of land for farming

Question 5

What are Conflicting Objectives? Example?

Answer 5

When governments face different and competing objectives, which one must be prioritised

E.g. may support industries producing demerit goods to prevent unemployment or loss of tax revenue, like cigarettes

Question 6

What are Information Gaps? Example?

Answer 6

When governments don’t possess full, accurate and up-to-date information, so they fail to accurately identify or fix problems

E.g. the reclassification of Cannabis in the 2000s, from a Class B -> C -> B

Question 7

What are Excessive Administrative Costs? Example?

Answer 7

When the cost of government admin to correct the market failure outweighs the benefit of intervention

E.g. if unregulated trade costs the economy £150m/yr, but a registration scheme costs £200m/yr

Question 8

What are Unintended Consequences? Example?

Answer 8

When government intervention causes negative and unintended consequences, causing a net loss of welfare

E.g. “Use it or lose it” budgets intend to reduce unnecessary budget allocation, but encourage reckless and pointless spending to avoid losing it next year