Government Intervention

Maximum Prices Market failure may occur when people cant buy basic necessities such as food and clothing. The government or an industry regulator can set a maximum price to prevent the market price from rising above a certain level. To be effective, a maximum price has to be set below the free market price.

Black Markets A black market (or shadow market) is an illegal market in which the market price is higher than a legally imposed price ceiling. Black markets develop where there is excess demand. Some consumers are prepared to pay higher prices in black markets in order to get the goods or services they want. With a shortage, higher prices are a rationing device. Good examples of black markets include tickets for major sporting events, rock concerts and black markets for children's toys and designer products that are in scarce supply.

Some goods have significant externalities in consumption. May attempt to correct the resulting market failure by raising their price to a level where MSC=MSB To be effective, a maximum price has to be set above the free market price. The issue is the black market if the excess supply makes its way to market.

Trade Pollution Permits Pollution Permits involve giving firms a legal right to pollute a certain amount e.g. 100 units of Carbon Dioxide per year. If the firm produces less pollution it can sell its pollution permits to other firms. However if it produces more pollution it has to buy permits off other firms.

Problems of Pollution Permits It is difficult to know how many permits to give out. The government may be too generous or too tight. Difficult to measure pollution levels. There is potential for hiding pollution levels. Administration costs of implementing the scheme.

Regulation To overcome market failure, the government may place laws and regulations which prohibit certain behaviour and actions. Laws prohibiting undesirable behaviour Legal age for smoking Prohibition on certain classes of drugs – cocaine, heroin Ban on drink driving above a certain limit. No drinking alcohol in certain city centres

Advantage of legal restrictions Simple and easy to understand. When the danger is great it may be better to ban it all together, e.g. heroin. When a decision needs to be taken quickly, a tax may be too cumbersome. A legal ban sends a clear signal that it is wrong (e.g. drinking alcohol in city centre) It is fairer than taxes. For example, people with high incomes may be willing to just pay more to drink and drive.

Disadvantages of legal restrictions There is little incentive for a firm to develop more efficient mechanisms. It may be socially inefficient to ban everything. e.g. you could ban cars in city centres, this would reduce pollution but could have adverse economic effects on business Raising the legal age may encourage people to break the law. Legal age restrictions on alcohol and tobacco can be hard to enforce. Taxes may be a better way of collecting money for government to spend on alternatives to simply banning. (e.g. tax on cannabis would enable government to raise funds) Prohibition can encourage the underground economy and give more economic power to criminal gangs who trade in drugs. Also, if drugs are illegal, they may be more likely to be poor quality.