Government Solutions to Market Failure: A handy Table

 

There are a variety of policies which authorities could use to intervene when the market fails (that is, when the market price does not reflect the 'true' cost or benefit of a good or service, and where the price mechanism cannot therefore work.)

 Different policies are suited to different failures. Below, I have set out the types of intervention, and then suggested which situations they fit.

Type of Government Intervention	Market Failures which the intervention is directed at	Examples
Indirect Taxation	Indirect taxes function well to raise the price and lower the supply of a demerit good. They punish producers and discourage demand where demand is inelastic, and make the consumers pay for externalities when the consumer is inelastic. They are therefore widely used to cope with negative production and consumption externalities, though they may be subject to various forms of government failure.	Taxes on alcohol (both excise and VAT in the UK; ) taxes on petrol (excise and VAT in UK; ) attempted taxes on high sugar drinks (Philadelphia, Washington DC, and San Francisco among other US cities; ) attempted taxes on fat in foods (Denmark 2011-2012)
Market Regulation (including maximum and minimum prices)	Regulation is appropriate where the market functions but can be volatile with large price swings, or where there are asymmetric information or different levels of power between buyers and sellers. It can act to stop the more powerful or informed stakeholders exploiting others, or doing things which increase welfare loss by providing goods or services with negative externalities.	Regulations against insider trading, and about the ways that trades can happen are appropriate for financial markets; licensing regimes operate in pharmaceutical and food (‘phytosanitary’) markets; minimum wage legislation in employment markets; and maximum and minimum price laws are sometimes found in rental markets to prevent abuse of monopoly power or exploitation.
Buffer Stocks	Sometimes physical interventions to prevent suppliers being damaged and dynamic markets spinning out of control are appropriate. With buffer stocks, authorities buy when the market price is low, and sell when the price is high, with the aim of keeping the price within a certain range. This allows providers to plan and not to be subject to big changes in income. For a buffer stock scheme to work, goods must be non-perishable, and storable. The legal word ‘fungible’ is also often used, meaning that each item of the good should be roughly the same as every other item—the economic equivalent is homogenous.	Buffer stocks are normally found in agricultural markets, but also in things like the strategic petroleum reserve of the United States (SPR.) The SPR usually contains around 30-60 days worth of oil and is held in storage caves beneath Louisiana and Texas. The President of the United States can release or build up the 600-700 million barrels worth of oil depending on market oil prices. Similarly, the European Common Agricultural Policy was at one point famous for its large supplies of buffer stock.
Tariffs	These are taxes placed on goods at the port of entry to an economy. The idea is that the extra charge on the good, which is taken from the importer but usually passed onto the customer, will protect domestic producers, compensate for unfair practices in production, cover externality costs of the good, or rebalance where an importer has benefited from exchange rate manipulation.	The period of globalisation between 1973 and 2008 saw extensive reduction of tariffs, but since 2008 they have become important as tools in trade disputes. They are also a key part of the post-Brexit debate, and can be found in EU-UK food and goods trade, for instance, as well as in any EU dispute with other blocs. The People’s Republic of China and the United States of America also use tariffs strategically.
Prohibition	This is where a product, good, or service has such high negative externalities, and is such a demerit good (overproduced and under-priced given the damage it does, imposing a deadweight loss on society which is very high) that it is simply banned. The ban does not eliminate the good, and may create an illegal market, but the relevant social authority has judged that this is an acceptable complication.	Bans on the private purchase or use of drugs such as morphine, amphetamines, LSD, cocaine, and cannabis derivatives; bans on most forms of private gun ownership outside of a small number of countries such as the USA; bans on certain kinds of filmed activity based on outrageous material which directly damages viewers and those participating in the filming, and society.
State provision	This happens in the case of public goods, but also where societies decide that merit goods have such positive externalities that they want the government to provide them. It allows for centralised control and distribution, often with economies of scale (and therefore lowest average cost across a range of output). It also tends to give the state monopsony power as the single largest buyer, which allows for wages and costs to be held down.	In Britain, most healthcare is provided by the NHS free at the point of delivery (leading to excess demand in the form of queues, rationing, and shortages but universal provision at low cost); education is at the time of writing mostly provided by the state in most countries; the state is the dominant or sole provider of money in most countries. Some people argue that the state should also provide natural monopolies like water, power, railways, police, defence forces, and communications networks, as well as prisons.
Transferable Credits/permits	These were a suggested response to the tragedy of the commons and incorporated the Coase Theorem. In situations where ‘everyone’ owns a resource there is a tendency for no-one to protect or cultivate it. One solution is state ownership, but with things like the atmosphere, there is no global state. Coase theory suggests that giving people ownership rights and benefits will cause them to behave in ways that improve general welfare. So, for instance, if states issue tradeable pollution permits, and set emissions targets for producers, any producer who over-emits carbon will have to buy permits, and any who cuts their carbon production will be rewarded by being able to sell permits. If a majority are below emissions levels, the authority involved can lower the permitted levels or withdraw permits to maintain the aims of the scheme.	The EU Emissions Trading System is the worlds biggest example of a ‘cap and trade’ system based on credits.
State provision of information to consumers	Sometimes markets function but goods or services are provided which have the potential for exploitation of customers, or welfare loss for the individual and society in the future. If the state provides information about goods and services, possible damage from purchase, or information about what a good or service contains or does, this can allow for more informed choices by consumers.	Food packaging information; state-sanctioned required explanations of medical or dental procedures; state-sanctioned and open compulsory records for cars and vehicles; warnings on cigarette packets.