When free markets fail to efficiently allocate goods and services, government intervention in markets can be used to address these failures. In a free market, prices and quantities are determined solely through the interaction of producers and consumers. When there is a market failure, governments can supply public goods for their citizens using taxes, regulations, and subsidies to deal with externalities, or side effects that arise from economic activities. Governments also intervene to prevent prices from being too high or too low by imposing price ceilings or price floors, respectively. By intervening in the marketplace, governments affect the supplies and prices of certain goods and services.
At A Glance
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Governments intervene in markets in a variety of ways, but the goal is to shift the allocation of resources to what is viewed as a more desirable distribution.
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Market failures result in an inefficient allocation of goods and services.
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Goods and services can based on whether the the items are excludable and/or rivalrous in consumption.
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Externalities are the effects of economic activities on uninvolved parties that cause the market to be inefficient, regardless of whether the externality is societally harmful or beneficial.
- Most market transactions involve some level of imperfect information. In order to reveal quality of goods and services, signals must be sent to help with the assessment
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Governments address market failures by using tools to affect the consumption of certain goods and services.
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Regulations alter the demand for goods or change the supply in the market.
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Taxes decrease demand for a good or service by raising the price the consumer pays. Subsidies increase demand for a good or service by lowering the price the consumer pays.
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Market approaches offer a flexible and efficient way of solving for market failures and accounting for social costs and benefits.
- The government uses price ceilings and price floors to protect consumers, but shifting prices away from equilibrium values can result in deadweight loss.
