Unit 3 Government

microeconomic
intervention (AS Level)
Chapter12/13 Reasons for government
intervention in markets
What is market failure?

• When markets work efficiently, they produce the best

allocation of resources. This is an ideal situation.
• In reality, as economies grow and become more
complex, markets do not always operate in the way
that is set down by economic theory.
• When this happens, there is market failure. Market
failure is an inefficient allocation of goods and services
in the market.
• In this case, the free market mechanism does not
make the best use of scarce resources.
• Market failure occurs when the price mechanism fails
to take into account all of the costs and benefits that
are necessary to produce or consume a product.
• Markets are not perfect due to inefficient production
and consumers not having perfect information about
price and quality of products or services.
• Microeconomics has many situations where market failure occurs,
and requires government intervention. These situations include:
• lack of public goods
• underproduction of merit goods
• overconsumption of demerit goods
• information failure
• The role of government: A consequence of market failure is that
government intervention can take various forms in order to
produce greater social equality and equity
12.2 How governments intervene in
markets
Addressing the non-provision of public goods
Public goods include the police force, national defense, fire protection,
street lights, non-toll roads and flood control systems.
The nature of public goods is that they are consumed collectively (by
everyone) and their use by one person does not make the public good
less available to others.
The free rider problem means that people can enjoy the use of a public
good without contributing towards its cost.
• It is therefore difficult or impossible, to make a direct charge for
consuming a public good. So, the private sector would not be
interested in providing public goods.
• Because of this reason, public goods have to be funded by the
government out of tax revenue and provided free of charge for the
public.
• Opportunity cost is an issue since the funding for public goods is
competing with other types of government spending.
Addressing the
overconsumption of demerit
goods
• Demerit goods are ones that are considered undesirable for
consumers and that tend to be over provided, therefore over
consumed in the free market.
• The main reason for this is that consumers lack proper information
on demerit goods such as cigarettes and tobacco.
• This is why governments have increasingly intervened in this
particular market and have introduced regulations, banning smoking
in public places .
• Manufacturers may be required to put written warnings and
photographs on packaging explaining the dangers of smoking.
• This will help protect the health and well-being of the population;
promotes a more productive workforce and to make savings in the
healthcare budget through treating fewer patients with smoking-
related complaints.
• These reasons have tended to be more relevant than the loss of tax
revenue through reduced sales of tobacco products.
Addressing the under consumption
of merit goods
• Merit goods are more beneficial to consumers than they may
realize. This is the result of information failure on the part of
consumers.
• For example, healthcare and education are both considered
by governments as desirable and able to act as an incentive
for economic growth and development.
• The problem for merit goods is that when provided by the
private sector, the quantity supplied is less than what is
required.
• Access is restricted to those who can’t afford to pay. This is
therefore a case of market failure.
Assume this is the market for
healthcare. The government
believes that OY should be
produced to meet the needs of
the population. This is
represented by the vertical
supply line. The private sector
only provides OX and this is at an
average price of p to those in
need of healthcare. This leaves
under production of OY − OX
• To correct the market failure, the government could decide
to fully take over the provision of healthcare.
• More resources would be allocated to meet OY for those
unable to afford to pay private sector fees.
Controlling prices in markets
Governments also set maximum and minimum prices. This means that
sellers of the good cannot sell it legally at any price above and below
the price ceiling.
In some former socialist economies and elsewhere, basic food items
such as bread were allocated a maximum price.
The reason behind this policy was to protect those on low incomes by
providing heavily subsidized items that were used daily.
To be effective the maximum price must be below the equilibrium
price.
Maximum Price or PRICE CEILING
(Upper limit)
• In some markets, governments intervene to keep prices of certain items higher or
lower than the market price or equilibrium price determined by the market
mechanism.
• A price ceiling occurs when the government puts a legal limit to determine price
of a product.
• In order for a price ceiling to be effective, it must be set below the natural market
equilibrium.
• It is also known as maximum price.
• Rent control is an example of a price ceiling, a maximum allowable
price determined by the govt. With a price ceiling, the government
forbids a price above the maximum.
• A price ceiling that is set below the equilibrium price creates a
shortage that will persist.
• The following diagram shows the application of maximum price.
Maximum Price Policy

For the price that the

ceiling is set at, there is
more demand (Q3) than
there is at the equilibrium
price. There is also less
supply (Q1) than there is at
the equilibrium price, thus
there is more quantity
demanded than quantity
supplied i.e. shortage.
Impact of Price ceiling
• Inefficiency: Inefficiency occurs since at the price ceiling quantity
supplied is less than quantity demanded, so the marginal benefit
exceeds the marginal cost. This inefficiency is equal to the deadweight
welfare loss.
• Existence of black market: Due to demand exceeding the supply,
there will be buyers who will be willing to purchase the good at a
higher price. This will lead to existence of black market.
• Disincentive to the producers: investment may decrease
How can government correct this
situation

• Subsidies may be offered to the firms to encourage the production of

such goods. However it involves an opportunity cost to the
government as they might have to divert funds from other activities.
• Government may also consider the option of producing the goods by
themselves.
• Government may also release previously stored inventory of such
goods to ensure that there is no shortage in the market, however, it
might not be possible for all the goods, for example, perishable
goods.
All the above
options will
lead to the shift
of supply curve
to the right and
thus forming a
new
equilibrium at
Pmax.
Minimum Prices or Price Floor

• A minimum allowable price set above the equilibrium price is

a price floor.
• With a price floor, the government forbids a price below the
minimum Price set by the government.
• Price floors are minimum prices set by the government for
certain commodities and services. It believes that these
goods such as farm prodcts are being sold in a market with
too low price.
• Thus their producers deserve some assistance.
Minimum Price Policy
Government might set Minimum prices

• To raise incomes for producers such farmers and protect them from
frequent fluctuations in the commodity market.
• To protect workers and ensure that they get a enough wages to
sustain a reasonable standard of living.
• Examples: In many countries governments assist farmers by setting
price floors in agricultural markets. Setting Minimum wages for
certain occupations is also an example of price floors.
Price floor

The equilibrium is Pe
and the Quantity is Qe.
The government thinks
that it is too low for
that good thus, set up a
minimum price for
Pmin.This will lead to a
fall in demand to Q1
and increase in supply
to Q2, thus creating
excess supply or
surplus.
 Consequences of a price floor

• Government can eliminate the surplus by buying the

excess supply at the minimum price.
• This will result in the shifting of demand curve to the
right, thus creating a new equilibrium at Pmin.
• Government may store it or sell it abroad.
• However, both these options have consequences.
Buying the surplus and storing it will cost an
opportunity cost for the government as they have to
divert funds from other important areas and exporting
it other countries may be considered as dumping.
Taxation
• It is a levy imposed by the government on the income,
wealth and capital gains of persons as well as business.
• It is a compulsory payment which has no direct benefit
provided for the tax payer.
• Government receipts income from taxes on personal and
business income, spending, wealth and capital gains.
• Taxes are imposed by the government for a variety of
purposes:
• (a) to raise revenue for the government to cover its own
expenditure on the provision of social goods
• (b) to use as an instrument of fiscal policy in regulating the
level of total spending in the economy
• (c) to make equal distribution of income and wealth
• (d) to manage import and export trade of the country.
• i) Direct tax: Tax imposed by government on the
income, wealth and capital gains of persons and
business (i.e. profit) is known as direct tax.

• The impact and incidence both of direct tax lay on

same person or business of those who have income,
wealth and profit. So it does not shift from person to
person.
Merits

• 1) Economy: The cost of collection of direct tax is the minimum

and it is based on the principle of economy. More amount of tax
revenue can be collected by less administrative effort.
• 2) Equity: It is based on ability to pay of the tax payer because
higher tax rate can be imposed to the rich and lower rate for the poor.
• 3) Consciousness: The direct tax payer himself bears the incidence
and impact of the tax so that they are conscious of their rights. It also
creates keen interest in the affairs of the state.
• 4) Reduce inequality: It can be progressive in nature because
higher tax rate can be imposed to the rich and lower rate for the poor.
Hence, the burden of direct tax will be equal for all income groups.
• 5) Certainty: Every tax payer will have to pay tax according to tax
law. There is no discrimination among the tax payers.
• 6) Elasticity: The rate of direct tax can be increased or decreased
according to the requirements of government revenue. Similarly, tax
revenue increases as an increase in income level of the people.
Demerits

• 1) Unpopular: It is quite painful to the tax payer, which is directly

imposed on individual's income, profit and property.
• 2) Possibility of evasion: Direct tax is imposed on income, wealth
and profit. The collection of tax revenue depends upon the
information provided by the tax payer.
Tax evasion is higher in case of direct tax because it depends on the
honesty of the people. Generally, people don't show their actual
income, wealth and profit.
• 3) Narrow in scope: Direct tax has narrow scope because it is
limited only on certain group of people.
• 4) Not suitable to underdeveloped economy: Direct tax is not
suitable in underdeveloped countries where very few people have
taxable income. Poverty and illiteracy are also the obstacles for the
successful implementation of direct tax.
• 5) Discourage capital formation: Direct tax reduces saving and
disposable income of the people which has adverse effects on capital
formation.
• 6) Inconvenience: Direct tax is inconvenient because it requires
more accounting and other formalities. Tax payer may feel uneasy to
show all his information of income and expenditure.
• ii) Indirect tax: Tax imposed by government on the goods
and services is known as indirect tax. It is shifted from one
person to another. So the impact and incidence of taxation
does not lie under same person.

• Value added tax (VAT), custom duties and excise duties are
some examples of indirect tax.
Merits

• 1) Convenience: Indirect tax is imposed on the price of good and

services and burden of tax does not feel by the taxpayer so that
people pay the taxes without any obligation.
• 2) Elastic: It can be changed as requirement of government. Even
the tax can be imposed on essential commodities to increase
government revenue.
• 3) No possibility of evasion: Indirect tax is already included on
consumption of goods and services, taxpayers have no chance to
avoid tax.
• 4) Wider coverage: It covers every consumer of the society. It can
be imposed on necessary, comfort as well as luxurious goods. Hence,
it has wider tax base.
• 5) Suitable for developing countries: More investment is required
to conduct development activities in DCs Hence, higher amount of tax
revenue should be collected from indirect tax.
• 6) Easy to collect: It is collected from different goods and services
in their prices. So it is easy to pay tax from their consumption.
• 7) Diversity: The burden of tax may not be centralized on certain
groups of people. It is diversified to the whole consumers. But it
should be implemented properly.
Demerits

• 1) Inequality: It is not based on equality principle. Every

individual has to pay same amount of tax on his consumption. So the
burden of taxation is high to the poor people and less to the rich.
• 2) Uncertainty: It is quite difficult to estimate the amount of
consumption of goods and services. So, the government is unable to
estimate the amount of tax revenue which is essential for planning
and budgeting.
• 3) Lack of consciousness: As tax is included on price of
commodity, tax payers are unknown about their contribution. Hence,
they may not conscious about government irregularities.
• 4) Discourage savings and production: This tax is included on the price, so
price of commodity will increase by this tax. As a result, people have to spend
more on consumption which reduces their saving.
• Indirect tax is also imposed on the capital goods which causes the price of capital
goods to go up, it leads to increase in cost of production and discourage the
producers to invest .
• 5) Inflationary: It causes price of goods and services to go up. Increase in
price of capital goods leads to increase in price of product which ultimately
increases rate of inflation.
Types of tax
Specific taxes:
• Specific tax is a fixed sum of tax which is levied on units,
quantity, weight, measurement etc. It doesn’t change with
the change in quantity of the product.
• For e.g. Excise duty. This tax causes a parallel shift to the
supply curve.
• Application of specific tax
• When a tax is levied on a product, it has some economic effect as the
increase in the cost of production.
• The cost of bringing the product to the market is now increased by
the same amount of tax.
• In terms of demand and supply, the imposition of tax may be seen as
a fall in supply.
• It can be shown in the following table and diagram:
Price Quantity Quantity Quantity
demanded supplied before supplied after
tax tax
10 100 1100 900
9 200 1000 800
8 300 900 700
7 400 800 600
6 500 700 500
5 600 600 400
4 700 500 300
• In the table, initial equilibrium price is Rs.5 and Quantity is
600
• TR Before the imposition of tax= Rs.3000
• New equilibrium price after tax is Rs. 6 and Quantity is 500
• New supply price= Rs. 4 ( for 500 units )
• TR after the imposition of tax= Rs.3000 (i.e. 500 X 6)
• Tax yield= Rs. 1000 (500 X Rs2 per unit)
• Suppliers revenue = Rs. 3000- Rs. 1000= Rs. 2000
The figure shows
that per unit tax is
Rs.2 which is
indicated by XZ in
the figure.
It shows that XY is
the burden of tax to
the consumer and YZ
is the burden of tax
to the producer.
Some examples about the burden of tax borne by
consumers and producers according to the PED

• In the cases of
• PED=Infinity
• PED= 0
• PED=1
• PED>1
• PED<1
PED= Infinity
PED=1
PED>1
PED>1
PED<1
PED<1
Class work task
• 1. Identify the tax burden of consumers and suppliers
with the help of diagrams:
• (a) perfectly elastic demand
• (b) perfectly inelastic demand
• (c) relatively elastic demand
• (d) unitary elastic demand
 In the case of PES= infinity and
PES= 0
• Consumer bears full burden of tax
in the case of PES= infinity
• Producer bears the full burden of
tax in the case of PES= 0
Ad valorem tax:

• It is one of the tax system based on the monetary value of goods and
services. Property tax, value added taxes etc.
• The amount of tax paid will rise with the increase in value of the
product purchased. It is levied on percentage basis.
• Ad valorem tax, which have the important advantage of adjusting the
tax burden according to the amount the consumer spends on the
taxed items.
Application of ad-valorem tax

• As ad-valorem tax is levied on a percentage basis, the

amount of tax paid will rise with the value of the product.
• It causes a non parallel shifts of the supply curve to the left.
• This is shown in the figure below:
Ad-valorem and specific taxes will
have different effects on the supply
curve.
• Since specific tax is a fixed amount whatever the price of the good, it
will shift the supply curve parallel upwards as shown in Figure 1.
The ad-valorem tax is a percentage of the selling price. This means that
at low prices the tax will be relatively little (10% of $1 is just 10c), but at
higher prices the tax levied will be higher (10% of $10 is $1). This
means that the supply curve shifts to the left and outwards as price
increases. This is shown in Figure 2.
SPECIFIC TAX: ADVANTAGES

• Predictable: Because the tax is not sensitive to changes in price, tax

revenues do not change when manufacturers change prices.
Therefore, government can predict tax revenue based on demand.
• Easy to determine the amount of tax: Specific tax is charged per
quantity or per unit. Therefore its easy to calculate and determine the
amount of tax.
• No effect on tax amount with the rise in prices of all products:
Specific taxes are fixed and do not depend on pricing strategy of an
industry. In addition, it reduces the gap in prices between cheap and
more expensive products.
• Easier to Collect. Costs of collecting specific taxes are low because it is
easy to count the number of products. Specific taxes are collected
once at a specific period of time, either from producers or retailers,
thus making tax evasion less likely and collection efficient.
DISADVANTAGES

• It doesn’t adjust with inflation: Specific tax rate is not tied to the
product price, it does not automatically adjust with inflation. Instead,
the government must implement additional tax rate and add into the
tax law to increase tax revenue.
• The amount of tax Can be reduced by changing products
characteristics. An industry can reduce the impact of specific taxes on
consumption. For example, by increasing the size of a pack if the tax is
levied per pack.
AD VALOREM TAX
• ADVANTAGES
• Automatic adjustment for inflation. Since the tax is tied to
the product price, the tax automatically adjusts with
Inflation.
• Higher profit margin is taxed. Ad valorem tax reduces the
industry profit margin since a part of any profit increase goes
to the government as tax revenue which can be used for the
welfare of the poor.
DISADVANTAGES
Less predictable revenue : As ad valorem taxes are based on value, it is
difficult to predict tax revenue over time.
Difficult to calculate the total amount of tax. Ad-valorem taxes require
more effort to calculate the payment. Manufacturers can easily
manipulate their product prices to avoid higher tax payments.
• Low prices. There is an incentive for manufacturers to produce low-
priced products because ad valorem taxes are tied to product prices.
• Leads to large price differences between products. Ad-valorem
taxation widens the gap in prices between low priced products and
more expensive products. More smokers may switch expensive
products to cheaper ones, and this may reduce the impact of higher tax
on consumption.
Proportional, progressive and regressive taxes

• On the basis of method or structure of income and wealth, tax may be

classified as follows:
• Proportional tax
• Proportional tax is a structure of taxation in which tax is levied at a constant
rate on the persons of different income levels.
• In other words, the rate of tax doesn't change as a change in taxable income.
It is an income tax system that levies the same percentage tax to
everyone regardless of income. A proportional tax is the same for low,
middle, and high-income taxpayers.
• Proportional taxes are sometimes referred to as flat taxes. The following
example illustrates the proportional taxation:
Taxable Tax rate Tax
income (in %) Amount
(in Rs) (in Rs)
10000 15 1500
50000 15 7500
100000 15 15000
• In the above table, as the taxable income is Rs
10000, the tax payer has to pay Rs 1500 which is
15% of his taxable income.
• As taxable income rises to Rs 50000, the tax
payer has to pay Rs 7500 which is again 15% and
so on. It is shown in the figure.
The proportional tax
curve is parallel to the
X- axis which means
equal tax rate is levied
for all taxable income.
Advantages
• 1, A proportional tax is simple, easy to understand and easy to
calculate as a uniform rate is charged.
• 2, Under proportional tax, the relative economic status of all
taxpayers remains unchanged because all pay tax at a uniform rate
regardless of their incomes.
• 3, Proportional tax does not have any serious or adverse effects on
the incentive to work and save of the taxpayers.
Disadvantages:
• 1. Proportional tax does not satisfy the canon of equality and justice
since the burden of this tax falls heavily on the poor persons. Both the
rich and the poor pay the same rate of tax. Thus, poor people sacrifice
more than the rich though they have lower incomes.
• 2. Proportional taxation cannot bring social justice. It widens
inequality in the distribution of income and wealth as the burden of
this tax is borne mostly by the poor people.
• 3. It is inelastic and, therefore, less productive.
Progressive tax

• Progressive tax is a structure of taxation in which tax is

levied at an increasing rate as income goes up.
• In this form of taxation, the rich should pay higher
and the poor should pay lower proportion of their
income.
Taxable Tax Rate Tax Amount
Income (in %) (in Rs)
(in Rs)
10000 5 500

50000 10 5000

100000 15 15000
• In the given figure, the progressive
tax curve is an upward sloping
which means higher tax rate is
imposed for higher income level.
• This tax system is equitable
because it is based on the
principle of ability to pay.
Benefits of Progressive tax system
• 1. In the first place, progressive taxes are equitable because rich
people pay more taxes as they have greater ability to pay.
• 2.As progressive taxes are based on the ability to pay principle, it
tends to reduce disparities in the distribution of income and wealth.
• 3. A progressive tax is productive as it yields more revenue.
Benefits
• 4. It is economical in the sense that its costs of collection tend to be
lower.
• 5. It is elastic. A rise in income during prosperity is automatically taxed
at a higher rate and a fall in income during recession is taxed at a
lower rate.
• Finally, progressive taxation is viewed as an engine of social
improvement. It is such rate of taxes that narrows down the
differences between the rich and the poor people of the society.
Disadvantages
• 1. The benefit principle states that who receives greater benefit from
the government activities should pay higher tax rate. Usually, poor
people are the largest beneficiaries and, they should be taxed more.
Therefore, It is against the benefit principle.
• 2. Progressive taxation dampens incentive to work and save, thus, it
lowers capital formation. Rich people save more than the poor. Now,
if the rich is taxed more, the incentive to work of the rich people will
decrease. Consequently, their savings and, hence, capital formation,
will suffer.
Disadvantages
3.There is a greater scope for tax evasion in the case of
progressive tax. Higher rate of tax encourages taxpayers to
evade their income by making false declarations of their
incomes.
• Regressive tax
• Regressive tax is a structure of taxation in which tax is levied
at a decreasing rate as income rises. It is quite opposite of
progressive taxation.
• In this form of tax system, high rate of tax is imposed to the
poor and low rate is levied to the rich.
• Examples regressive tax: sales tax, property tax, excise
tax, tariffs, and government fees.
• As the taxable income is Rs 1000, tax payer has to pay 10% of
his taxable income.
• As taxable income is Rs 20000 and Rs 30000, the tax payer
has to pay 7% and 5% of income as a tax respectively.
• Regressive tax system can
be shown in the given
figure:
• The regressive tax curve is
downward slopping which
indicates that higher tax rate
is levied for lower income
and vice versa.
• This tax system is not
equitable and it is against
the principle of ability to pay.
Advantages:
• 1. Encourages people to earn more: When people at higher income
levels pay lower levels of tax, it creates an incentive for those in lower
incomes to move up into higher brackets. So for someone earning
$39,000 and paying 15% tax, it makes little sense to earn $50,000
which takes them into a bracket that pays only 10 percent.This
encourages people to move into more productive and higher-paying
positions.
• 2. Higher Revenues: This may seem strange, but when taxes on the
rich are lower, they tend not to take such extreme measures to avoid
paying it. This is because the incentive to avoid is lower. Therefore,
there is higher possibility to increase government revenue.
3. Increases Savings and Investment: In a regressive system, those who earn
higher incomes tend to save more, thereby increasing the saving rate of the
nation. In turn, those savings become capital available for businesses to invest
in new productive and more efficient machinery.
4.Simplicity: Regressive tax is also flat tax but is regressive in nature. Therefore,
it is simple in implementation. For instance, the sales tax is 5 percent tax on
each and every item.
5. Reduces a ‘Brain Drain’: When tax rates are more progressive, it can result in
a loss of talent, also known as ‘brain drain’. This is where skilled professionals
leave the country to find work elsewhere. By implementing a regressive system
that lower taxes to the rich, provides an incentive for highly skilled
professionals to work for the nation.
Disadvantages:
• 1. Inequality: A regressive tax imposes a higher tax burden on those with lower
incomes than those at higher incomes. Therefore, it creates a downwards
pressure to the poor. They are forced into paying a higher percentage of their
incomes in tax, thereby leaving less for them to save. In turn, a poverty trap is
created to the low-income households.
• 2. Higher Prices: Consumers face higher prices for various imported goods. For
instance, higher excise taxes are imposed on various goods such as sugary drinks,
cigarettes, and alcohol products. In this case, higher burden of taxes are often
associated with low-income households.
• 3. Reduces Competition: Regressive taxes such as excise taxes, tariffs,
and sales taxes, all help reduce demand for goods. As prices are
higher, there is less demand, and because there is less demand, there
is less room for competition.
• 4. Political Unrest: Taxation will always be a moral issue. However,
when it starts affecting a significant number of households
disproportionately, people can become discontented. In turn, we
often see sharp turns in the political conditions because of the
dissatisfactions of low income group.
Construct diagrams from the given
table:
Subsidy
• Financial help given by the government in order to encourage the
production and consumption of goods and services.
• Specially govt provides subsidy to correct the condition of market
failure due to positive externality.
• The government provides subsidies to the producers due to the
following reasons:
• To keep down the market prices of essential goods
• To encourage greater consumption of merit goods
• To contribute to a more equitable distribution of income
• To provide services that would not be provided by the free market
• To raise producers’ income, especially in the case of farmers
• To provide an opportunity for exporters to sell more goods
• To reduce dependence on imports by paying subsidies to domestic
producers of close substitute
• There are two types of subsidy given to the producers and consumers.
• Specific subsidy and ad valorem subsidy
• Ad-valorem subsidy : provides as a percent of the value of goods and
services.
• Specific subsidy: provides on a flat rate.
• The following figure
shows the condition
of specific subsidy.
• Here in the figure BC
is the subsidy per
unit
• BM=partofconsumers
• CM=partof producers
• The following figure shows
the condition of ad-valorem subsidy.
• The figure shows that higher
the price, large the amount
of subsidy given to
the producers and consumers.
•In this case, the
government is giving
a subsidy of £14 (36-
22). The subsidy
shifts the supply
curve to the right.
•It leads to a lower
market price. Price
falls from £30 to £22.
•Quantity demand
increases from 100
to 140
MCQs ( QUIZ)
Direct provision of goods and services:

• Governments provide certain important services free of

charge at the point of use or consumption. Such services are
financed through the tax system.
• If these services are used equally by all citizens, then those
on lowest incomes gain most as a percentage of their
income, thereby lowering inequality.
• The two most common instances of direct provision are
merit goods and public goods
• Merit goods, such as healthcare and education, are provided
free in some but not all economies.
• The characteristics of public goods mean that they will not
be provided by the market mechanism. Neither will
consumers be willing to pay for them.
• The only way in which they can be provided is directly by the
government and paid for out of tax revenue.
• A frequent criticism is that this leads to inefficiency, with
costs higher than what would have been the case in a
competitive market.
• There are major differences in the direct provision of goods and
services between economies, for example in healthcare provision. The
UK has had a free National Health Service for more than 70 years; in
contrast, free health care in the USA is limited.
• In most low-income countries, Cuba being a notable exception, a
charge is usually made for most types of healthcare provision.
• This is especially the case in many African countries where only a
very basic system of healthcare is provided free of charge.
Effect of direct provision of
goods and services on the
market
• Merit goods are subject to various market failures. However
these failures do not justify free provision to the consumer.
• The justification must be on the ground of equity.
• The view is that every one should have access to a certain
level of health care and education regardless of income as
universal benefits.
• The direct provision of goods and services is also a
controversial issue. The main criticism is that the
government over provides especially where no direct charge
is made.
• Resources are not allocated efficiently. If a charge is made or
introduced , demand is likely to fall.
• It can also be argued that many consumers could afford to
pay a charge. So it reduces tax burden and allowing the fund
to be put to alternative uses.
Buffer stock schemes
• A buffer stock scheme is designed to smooth price rises and falls by
buying and selling stocks of products depending on market conditions.
• In general terms, buffer stock schemes combine the principles of
minimum and maximum price controls.
• A buffer stock scheme starts by setting a minimum price for a
particular product, say potatoes. If the market price looks like going
below the minimum, the buffer stock scheme will buy up stocks of
potatoes from growers.
• These will be stored in warehouses. This action should raise the price
of potatoes since supply in the market has fallen.
• The scheme can also set a maximum price. The effect will be to
increase demand and scheme will increase supply from stock and
maintain stable price .
• For many years, the European Union’s (EU) Common Agricultural
Policy (CAP) was an example of this type of intervention. The CAP was
heavily criticized for its inefficiency. This resulted in CAP focusing
instead on implementing structural reform to make agricultural
production more efficient.
Single price system in Buffer stock
Provision of information
• Information failure can result in the under consumption of merit goods and the
over consumption of demerit goods. It therefore seems logical for the
government itself to use information provision as a form of direct intervention. A
few examples are:
• compulsory information on cigarette packets warning of the dangers of smoking
• public health announcements and campaigns
• advice on non-prescription medicines
• nutrition and allergy information on food packaging