What this lesson teaches
I can judge how well each policy works and explain government failure.
Syllabus 9570, 2.3.3(c). Microeconomic Policies: Effectiveness of policy measures and government failure
Make a guess
A tax on a polluting good cuts output below the efficient level. Is this government failure?
- Yes. Any policy that misses the efficient output is a failure.
- Only if the outcome is worse than doing nothing.
- No. A tax can never make things worse.
Show the answer
Only if the outcome is worse than doing nothing.
Overshooting creates a new loss. If that loss plus running costs is larger than the original loss, the policy made things worse.
Government failure happens when intervention makes resource allocation worse, not better.
Governments step in to correct market failure, but they can get it wrong. Government failure is when intervention leads to a worse allocation of resources than before.
Causes include imperfect information (the tax is set at the wrong level), unintended consequences (a ban creates a black market) and high administrative costs.
A policy that falls short of the efficient output is not government failure if it still improves on doing nothing. It is government failure only if the outcome is worse.
In an exam, this is strong evaluation: ask whether the government has the information and tools to improve on the market.
- Definition
- Intervention makes allocation worse.
- Causes
- Poor information, unintended effects, high costs.
Worked example: A tax set too high
Without intervention, output is 80 and the deadweight loss is $40 a day. A tax cuts output to 40, well below the efficient 60. The remaining loss is $40, and running the tax costs $10 a day.
- Before: loss of $40.
- After: $40 from underproduction plus $10 of running costs = $50.
- The policy made things worse: government failure.
- A smaller tax, closer to the external cost, would have improved the outcome.
Watch out for this
Any policy that does not reach the efficient output is government failure.
Only if the outcome is worse than doing nothing. Partial improvement is still improvement.
Check your understanding
Which is an example of government failure?
- A ban creates a black market that causes more harm than the original problem it targeted.
- A subsidy raises vaccination rates, though it costs the government money.
- A tax cuts pollution and raises revenue, but not quite to the efficient level.
Show the answer
A ban creates a black market that causes more harm than the original problem it targeted.
Right. The intervention makes the allocation worse.