Cambridge International as and a level Economics Ebook

Government failure in 
microeconomic intervention
The eff ectiveness of government policy
In principle, government policies to reduce market 
failures make economic sense. Th
ey increase the level of 
economic effi
ciency in markets and thus must be judged 
to be economically desirable. However, in practice, all may 
not work out as planned. Governments may themselves 
fail. Th
ere are reasons why government intervention may 
in fact create further ineffi
ciencies and so not improve 
the use of scarce resources in a society. Th
is is known as 
government failure
.
Government failure: 
where government intervention to 
correct market failure causes
 
further ineff iciencies.
KEY TERM
Figure 8.19 
The eff ects of the introduction of a minimum wage
3.60
2.50
Quantity of labour
Quantity of labour
0
W
age rate (US$)
W
age rate (US$)
D
S
3.60
2.50
0
D
S
(a)
(b)
W
m
W
mrp
Quantity of labour
0
W
age rate 
Marginal cost
D
= Marginal
revenue product
L
m
Average cost
Figure 8.20 
A monopsony buyer of labour
212
Cambridge International A Level Economics

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Th
ere are three main reasons why government failure may 
occur. Th
ese are as a result of:
1
imperfect 
information
2
undesirable 
incentives
3
policy 
conflict.
Problems of imperfect information
Once the government starts to intervene in the running of 
markets, it needs information. Th
e correct policies can only 
be introduced if governments have the correct information. 
Th
e problem is that governments may have inaccurate 
information. In this case, they may introduce policies that 
lead to greater economic ineffi
ciency. Some examples of 
this problem could be the following:
■
There is a lack of information about the true value of a 
negative externality. It is oft en very diff icult to give an 
accurate figure for the value of a negative externality such 
as pollution. It is diff icult both to put an accurate figure to 
all of the external costs imposed and to trace the source 
of the pollution itself. The problem with this is that it then 
becomes very diff icult to impose the correct value of a tax 
that attempts to reduce production to an eff icient level. The 
wrong level of tax will lead to the wrong level of production.
■
There is a lack of information about the level of consumer 
demand for a product. If the government is providing 
a product free of charge to the consumer, then some 
estimation of the level of consumer demand is required. 
This could be the case with a public good. However, the 
government must try to provide the right amount of 
such goods. If it does not estimate the level of demand 
accurately, then the wrong amount will be produced and 
thus there is ineff iciency.