It was suggested by Adam Smith in 1776 that individuals led by self interest, accidentally advance the interests of society.

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HND Social Science

Public Sector Economics

Unit Number: 6420222

Outcome, 4

Langside College Glasgow

Author: Alex Leckie

Lecturer: Janet Cole

Submission: 29/01/2003

       It was suggested by Adam Smith in 1776 that individuals led by self interest, accidentally advance the interests of society.  If this is true and the selfish free market economy efficiently allocates resources at minimum cost, why is there a need for any government intervention in the economy?  A simple answer for this is the concept of Market Failure.

       Market failure is the incapacity of an unfettered market to efficiently allocate resources in certain situations.   There are diverse reasons why efficiency may not be achieved some of these are:

Public and Merit Goods

Many goods and services that we take for granted would not be provided for in an unregulated free market without government intervention.  The legal system, defence forces, schools, roads and health services are just some of the benefits we receive due to this intervention.  Admittedly the private sector has recently become involved in some of these but all are still very much regulated by the government.

A pure public good is a good or service which can be consumed by everyone and from which no-one can be excluded, national defence and light houses are two examples of this. A public goods are non-rivalry i.e. one person's consumption does not reduce the amount available for someone else and they are non-excludable i.e. no-one can be stopped from using the good or service.

The problem with public goods is that payment cannot be regulated at the point of consumption.  This introduces free riders, which is somebody who consumes a good or service without paying for it. This problem is particular to public goods because of the difficulty in regulating payment at point of consumption. Due to this the service would not be provided for in an unregulated market hence the requirement of government intervention. 

Imperfect Information

It is assumed that under perfect competition, consumers have perfect knowledge about prices and products. This may be the case if a C.D. Player is being purchased and consumer magazines are freely available giving all the pro’s and con’s without bias to help people make an informed choice.  However in cases such as health care, full information is much more difficult and the consequences of purchasing the wrong service are much more serious for this reason again the U.K. government intervenes to ensure the well being of our society rather entrust us to possible Market Failure and see us purchasing two for the price of one hip replacements where only in the small print do you find reference to the fact that it is two right hips you are now going to have rather than the conventional one right and one left.

Immobility of Factors and Time Lags in Response (Unemployment)

Even under perfect competition certain factors may be slow to respond to changes in demand and supply conditions. Labour is one such factor, it is often geographically and occupationally immobile. This can lead to unemployment, in one area either geographically or occupationally while other areas are experiencing higher wages and demand.  Eventually the market may try to reach equilibrium but in the mean time due to the dynamism of markets other changes will have occurred.  Therefore the economy is in a continuous state of disequilibrium and the long run for many markets never comes.  The government again intervenes in this market failure by providing incentives for companies to locate in certain areas it can also provide training courses etc. to encourage school leavers to train in the trades it requires for the future.  It may also subsidise businesses that it believes may be experiencing a temporary fluctuation in the market.

Inflation

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        Many believe that inflation can be looked at as another market failure, particularly wild fluctuations of the level of inflation.  This has many causes but if we limit it to the labour supply as above we can see how through unionised labour the labour market can greatly affect other markets forcing price rises and inflation.  The government can intervene in many ways and reduce the union’s power and thus prevent the monopoly or oligopolies that unions have over the labour market.

Market Power

Perfect Competition is rarely to be found in any market, the existence of Oligopolies and Monopolies lead ...

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