Government in the Economy
The Limits of Markets
1- Why governments intervene
● he free market has limitations
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● Government intervention is needed to provide more just outcomes for society
● Market failure occurs when the market forces fails to create favourable outcomes in the economy
● The price mechanism fails to take into account social costs and benefits of production
2- Market failure in the provision of goods and services
● G overnment will step in to provide non-rival and non-excludable goods. They attract free riders,
because the market fails to provide these goods
● No incentive for private sector to provide them
● Non rival: Ones enjoyment of a public good does not diminish the potential for others to enjoy this good
● Non-excludable: No incentive for firms to produce public goods if consumers aren’t willing to pay for
them
● Free riders: Group of individuals who benefit from a good or service without contributing to the cost of
supplying a good or service
● Public goods: Goods that the private firm are unwilling to supply and hence are provided by the
government such a defence, lighthouses and historic monuments
● Merit goods: Goods that are not provided in sufficient quantity by the free market because individuals
do not place sufficient value on the goods despite the positive externality they provide
● Demerit goods: The opposite of merit goods. The free market produces too much of the good and the
government acts to restrict or prohibit their use. They generally have negative externalities and
including things such as gambling, tobacco and alcohol
● The government has a monopoly over these products
● Monopolisation: When a firm uses its dominant market power to eliminate existing competition or to
prevent new firms from entering into the market
● Government owned monopolies: Often a natural monopoly will exist where the government provides a
public good. These monopolies often arise as the infrastructure required to compete is prohibitive. E.G
Australia Post, Citadel
● Corporatization: The operation of a government owned business so that it is run along the same
principles as a private sector business, although retaining government ownership
● Privatisation: The sale of a government owned enterprise to the private sector (E.g- Qantas, Comm
Bank)
3- Market failure in income distribution
● T he free market would produce a substantial level of inequality in this distribution of income without any
government intervention
● Firms reward those with the highest skills and education levels
● Would be vast differences in levels of income without the labour market and taxation regulation
● Governments can improve equality by providing health and education services to those on the margins
to improve quality of life
● Government redistributes income via taxation and welfare payments, in order to reduce the poverty gap
in Australia
4- Market Failure in Externalities
● A n externality is a positive or negative consequence that a firm does not consider when they make
production decisions
● Negative externalities: Negative consequences of private production decisions that have harmful
effects, usually on the environment
o Carbon emissions from electricity generation
o Transport or noise pollution
o Environmental degradation from incorrect disposal of waste
5- Market Failure in the Abuse of Market Power
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● arkets are competitive: there will be times when the market fails
● Firms may abuse their market power in order to reduce costs or eliminate competition in an illegal
manner
● Key forms of abuse are:
o Monopolisation: When a firm uses its dominant market power to eliminate existing competition
or prevent new firms from entering
o Price discrimination: When a firm sells the same type of good or service in different markets at
different prices
o Exclusive dealing: When a firm sets conditions for supply that exclude retailers from dealing with
other competitors
o Collusion/market sharing/price cartels: When firms get together and agree on pricing and market
sharing agreement
ctivity 1
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These words are important to the topic and must be used in your writing.
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Key efine the word in your own words and provide an example.Do not google it.
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Terminology ❌❌❌
Free Market
Merit Good
Demerit Good
Market Failure
Externality
Public Good
Medicare
Floor Price
Ceiling Price
1. Outline reasons for government intervention in theMarket.
2. What is a Merit good? Give an example.
3. What is a public good? Give an example.
4. What is a good demerit? Give an example.
5. Contrast the difference between a positive and negative externality in the market.
Activity two
6. What is a floor price? Give an example.
7. Draw the graph that shows the effect of establishing a floor price on beef?
8. What is a ceiling price? Give an example.
9. Draw the graph that shows the effect of establishing a ceiling price on petrol?
Activity Three (in your book)
