RATIONALE FOR INTERVENTION
Free markets: theoretically unregulated markets should generate an efficient allocation of resources so that social welfare is maximised. Competition amongst producers will force firms to be allocative and productive efficient, whilst consumers sovereignty will mean that producers only produce those goods which consumers want. Prices will reflect the true costs and benefits of economic activity
Market failure: the workings of free unregulated markets do not give an efficient allocation of resources, which results in economic welfare being maximised.
Examples include:
Externalities: positive and negative externalities are ignored
Missing markets: public goods are not provided
Incomplete markets: merit and demerit goods provided in the wrong quantities
Monopoly: lack of competition in some markets
Inequality: uneven distribution of income and wealth
Unstable markets: excessive extremes in the business cycle
Government intervention should ensure that economies move towards a more socially optimal allocation of resources
Intervention can take place in a variety of ways. The major ones
operate through:
Using the price mechanism: using taxes and subsidies to influence production and
consumption of goods
Regulation: using legislation to enforce policy
Education: encouraging people to alter their behaviour