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Government Intervention in Markets

Why and How Do Governments Intervene in Markets?

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.

In a market-oriented economic system, scare resources are allocated via a decentralized price system, that is, an economic system in which prices are determined by many different entities, including multiple buyers and sellers. The equilibrium price and quantity are determined by economic agents interacting in markets and engaging in exchanges. Demand and supply adjust based on market conditions and revealed signals, and this is the most efficient economic system in existence today. So, why do governments intervene in markets?

Governments may choose to intervene in markets for various reasons. These reasons usually result in an overall goal of changing the allocation of resources to what is viewed by politicians and their constituents as an improvement in the distribution.

The main and most logical reason for intervention is to correct market failures (situations in which equilibrium levels produced by the free market are inefficient), especially in the case of externalities. In the case of externalities, the market is not accounting for social costs and social benefits that affect third parties not involved in the market transaction. Governments may intervene to correct for this using taxes to help account for social costs and subsidies (money given by the government to businesses to keep prices low) to help account for social benefits. Other reasons include trying to achieve a more balanced distribution of income, or engage in price controls, taxes, or subsidies through legislation. These types of intervention usually have a goal of benefiting constituents or shifting allocations to a more favorable outcome, but often come with the tradeoff of a social or deadweight loss, which is loss to the economy caused by resources being used inefficiently.