1. Explain the major causes of market failure?
How the government can intervene to address
each cause of market failure?
Market failure refers to the situation in which the free-market mechanism fails to
allocate goods and services efficient, hence leading to a net loss off economic value.
When the free market fails to distribute efficient the available good and services it leads
to lack of equilibrium and no any pareto point is attained, hence leading to government
intervention. Example when the monopolist set the high prices of products leaving no
choices for the consumers rather to purchase the overpriced products.
Major causes of market failure include;
Externality, An Externality results when the actions of an individual or firm have direct,
unintentional, and uncompensated effect on the well-being of other individuals or profits
of other firms. Example If a neighbor keeps their houses and flower gardens well
maintained, the value of the houses in that neighborhood is likely to rise. Externality it
leads to market failure such as example
In a steel industry, Steel furnaces typically burn coal, emitting sulfur dioxide, nitrous
oxides and particulate matter, Let’s assume there is a fixed relationship between the
amount of steel produced and the amount of pollution emitted, say for every one
thousand tons of steel produced, one ton of Sulphur dioxide is emitted. The amount of the
pollution causes damage to downwind residents.
There is a marginal damage of pollution function which is dependent on amount of steel
produced
Externality
In the absence of regulation, steel producers will ignore the damages caused by pollution,
The supply curve here corresponds to only the private marginal costs of steel (PMC). These
will lead to dead weight loss indicating inefficient due to externalities.
Government solves the problem of negative externality, by imposing taxes together with
tariffs on goods and services produced that generates spillover cost. Example When
regulation forces the steel industry to internalize the marginal damage as part of their cost,
the supply curve will now be SMC. Hence the equilibrium output of steel will Q* which is
efficient.
Public goods are goods which are both non excludable and non-rivalrous. These goods are
shared by all people in the society but owned by no one in the society. Thus, they are
characterized into non excludability in consumption and non-rivalry. Public goods lead to
market failure when the cost of public goods does not increase with the cost of number of
users of the public good. When the free rider problem rises due to continue to use the public
goods without paying through taxes, then lead to the market failure problem.
The government solves the problem of free rider through subsidized people to provide the
public good, the market will adjust and fix itself so the public good will be provided without
interference. Also, government taxes people and uses the revenue to provide the public good.
Market power (monopoly power), monopoly is the single supplier controlling the entire
supply of the product in the economy. Since the monopoly are oriented with high profit
hence charging high price of product leading to rigid demand curve with high price but low
quantity supplied in the economy. Hence monopoly causes deadweight loss or lack of
equilibrium between supply and demand.
Also, the government controls the monopoly power which leads to market failure through
fixing either price or certain quantity of good to produced or both. The government uses the
antitrust laws and regulation to discourage monopoly power hence ensure efficiency in the
economy.
Incomplete information, lack of information by buyers and sellers about the prevailing
price and quantity of product available, lead to market failure when they may buy or sell a
product at higher or lower price than what would be reflective of its true benefit or cost.
Also, imperfect information may discourage entry in the market leading to low supply of
products in the market.
The government solves the problem of imperfect information by insuring there if full
disclosure of information to the buyers and sellers on prevailing prices and products
available in the market.
2. Explain the major fiscal functions of the government.
Fiscal function refers to the use of the government spending and taxations to influence the
economy by ensuring stable economic growth and better living standard of the people in the
economy. The function of the government used in the provision of social goods or the
process by which total resource use is divided between private and social goods and by
which the mix of social goods is chosen. The following are major fiscal function of the
government
Allocation function
The provision for social goods, or the process by which total resource use is divided between
private and social goods and by which the mix of social goods is chosen. This provision may
be termed as the allocation function of budget policy. Social goods, as distinct from private
goods, cannot be provided for through the market system. The basic reasons for the market
failure in the provision of social goods are: firstly, because consumption of such products by
individuals is non rival, in the sense that one person's partaking of benefits does not reduce
the benefits available to others. The benefits of social goods are externalized. Secondly, the
exclusion principle is not feasible in the case of social goods. The application of exclusion is
frequently impossible or prohibitively expensive. So, the social goods are to be provided by
the government.
Distribution function
Adjustment of the distribution of income and wealth to assure conformance what society
considers a 'fair' or 'just' state of distribution. The distribution of income and wealth
determined by the market forces and laws of inheritance involve a substantial degree of
inequality. Tax transfer policies of the government play an important role in reducing the
inequalities in income and wealth in the economy.
Stabilization function
Strategies that maintaining the monetary, taxation and revenue policies without a negative
effect to the economy and its operations. Government can use monetary policy and fiscal
policy to influence economic performance. Fiscal policy helps the economy achieve growth,
full employment and price stability while monetary policy used to control the money supply
and interest rate. Examples stabilization of the economy include full employment, control
inflation and equitable balance of payments
Economic Growth function
The government is not only having the function of maintaining high employment or of
curtailing inflation within a given level of capacity output, but also have the function to
ensure the stable economic growth through high productivity and having better living
condition of the people within the society.
3. Explain various ways used to measure attitudes of citizens towards fiscal programs
Fiscal programs, are programs that involves the use of government revenue collection and
expenditure to influence a country’s economy by expanding or contracting fiscal policies for
example expanding government spending, lowering tax to stimulate investment
The following are ways used to measure citizen attitude towards fiscal policy
(i) Sample survey as tool for measuring attitudes towards fiscal policy: - it insights into
people’s attitudes toward fiscal policy program are needed by both policy makers and
fiscal theorists. Although popular preference cannot be regarded as the mandate to
policy makers, information on how people feel and what they want should be
available and should have some bearing on policy decision by use of statistical
technique
(ii) Theoretical work on the problem of budget determination by economists: - This quite
properly has emphasized such criteria as fiscal soundness, economic stability,
economic growth and income redistribution at the same time it is agreed that, in
addition to promoting these ends, fiscal policy should be governed by criterion. The
maximum welfare principle of budget determination requires that marginal outlays be
allocated between private and public goods and between alternatives government
program in accordance with consumer preference.
(iii) Personal interview survey can throw light on the citizen’s attitudes towards
government spending programs: - the level of taxation and budget deficits. More
important, survey can give us some understandings of the nature of the people’s fiscal
preferences, their origin, congruences, and stability
(iv) Measuring attitudes towards public spending using multivariate tax summary
experiment: This experiment involves how much money should the government
collect in taxes, and how should it spend these resources across different policy areas?
These two questions about the public budget are among the most important choices
that governments make: They both change the material positions of citizens and enact
political and social priorities. With this in mind, pollsters and political scientists have
long sought to measure public attitudes regarding how much the government should
tax and spend overall, and how much citizens want spent on different things. But
despite the importance of taxation and spending itself, and of public opinion about
taxation and spending to democratic governance, we lack good strategies for
measuring these basic political preferences.
