The free market model based on voluntary exchange is assumed to be beneficial for all parties. However, markets are not perfect, and often they fail to meet social efficiency, and that is why the role of governmental regulation is justified. The cases when markets do not correspond to society’s requirements are called market failures. According to Sloman and Garratt (2013), there are four types of failures, including market control, imperfect information distribution, public goods misallocation, and externalities. Governments are responsible for imposing regulatory or market-based policies that mitigate negative outcomes of market failures and promote social benefits.
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Air Pollution as a Negative Externality Example
Negative externalities are either monetary or non-monetary costs of market activity imposed on third parties. They can be defined as “‘third-party’ effects, of production or consumption” (Sloman and Garratt, 2013, p. 168). Although the businesses often think of the marginal costs as final, there are other external production costs that do not influence prices. The marginal social cost of production is the change of the marginal private cost that includes external expenses. MSC can be defined as the sum of MPC and MEC, where the latter can mean healthcare costs caused by air pollution or the loss of working hours due to illnesses.
To reduce the impact of negative externalities, governments use regulatory and market-based policies. The first type of regulation implies imposing rules and quotas to limit the negative effect. The latter strategy is generally preferred more as it imposes taxes and tariffs on environmentally unfriendly production, thus increasing the social benefits. The American Clean Air Act regulates the emissions from factories using the combination of policies from banning toxic pollutants to imposing extra taxes on production. According to Currie and Walker (2019, p. 3), it has had a substantial impact as “air quality in the United States has improved dramatically over the past 50 years.” Thus, through the system of taxes and subsidies, governments can promote the transition to renewable energy sources and improve the environmental situation.
Public Goods Allocation as the Example of Market Failure
Public goods, such as police, the army, or the government itself, are characterised by non-excludability and non-rivalry, which means that everybody can use them without restricting their use for others. As there is no competition or payment for such goods, businesses cannot make a profit, making them a governmental responsibility. Although Sloman and Garrat (2013) claim that medical services cannot be considered as a public good, the examples of different countries show that the private competitive healthcare market fails to provide social equality. Private firms do not feel responsible for providing coverage of all social groups.
The issue is especially pressing in such countries as the USA, where many individuals cannot afford essential medical services. The countries that prioritise public health choose to make healthcare equally accessible to different social groups, funding it from taxes. Papanicolas et al. (2019) claim that the UK healthcare model proved to have better public health outcomes with lower per capita expenses than in other high-income countries. The governmental regulation of public goods is typically founded on market-based policies, where every member of society benefits from market activity.
Despite the advantages of free competition, markets often fail to sustain the basic needs of society. Different types of market failures require the involvement of the government that imposes either market-based or regulatory policies. The role of government is not in hindering business activity but in maximising social benefits from it while minimising negative externalities. Governments and businesses are not the opposing forces, as the better is the economic performance of the country, the more taxes it gets to provide public services or sustain the environment.
Currie, J. and Walker, R. (2019) ‘What do economists have to say about the clean air act 50 years after the establishment of the environmental protection agency?’ Journal of Economic Perspectives, 33(4), pp. 3-26.
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Papanicolas, I., Mossialos, E., Gundersen, A., Woskie, L. and Jha, A.K. (2019) ‘Performance of UK National Health Service compared with other high income countries: observational study’, Bmj 367, pp. 1-12.
Sloman, J. and Garratt, D. (2013) Essentials of Economics. 6th edn. Harlow, UK: Pearson.