Difference between government failure and market failure
Market failure examples
If individuals know that the state will provide unemployment benefit, or free treatment for their poor health, they are less likely to take steps to improve their employability, or to avoid activities which prevent poor health, such smoking, a poor diet, or lack of exercise. As the previous paragraph shows, the problem of public goods is a subset of the more general problem of externalities. Why would that occur? So the economist Mike Munger has a sort of joke about this. There are also negative externalities. Excessive bureaucracy is also a potential government failure. That last condition was not a misprint. If we all care about the suffering of the poor and I give money to relieve that suffering, I am not just helping the poor; I am also helping you, the early Friedman reasoned. We might not bother with ABS brakes and so on.
It looks just like the ideal economic system. People can make an effort to influence public policy in many ways. Each of us has an incentive to be a free rider, since we benefit from the change whether or not we help get it passed. There can be political entrepreneurs, of course.
Or to use the language of economics, the transactions costs of getting agreement at such a convention would be almost infinitely high.
That attitude is strange, when you stop to think about it. The existent of market failure is often taken as an excuse for government intervention to do whatever markets fail to do. If there is a public good that needs to be produced digging a well, for examplethere is nothing to prevent them from agreeing to produce it and agreeing on how to share the cost.
Once they have done that, there is no way to make one person better off without making someone else worse off. However, on the other side there are likely to be special interests who will oppose the bill. This is caused by the public sector when it tries to solve the principal-agent problem. Market Failure vs.
Causes of market failure
The same principles apply to legislation. But there is no natural tendency for them to move us in the direction of a Pareto Optimal world. They often fail in very small ways and sometimes they fail in very big ways. Global warming is one example. The implication is that market prices and market movements should be free from interference because markets cannot be improved upon by individuals or governments. I am going to define government as the sphere of activity where everything is coercive. But the delusions of libertarians are more than matched by the delusions of people on the left when it comes to the actions of government. National defense is another. Many economists believe in the efficient market hypothesis, which assumes that the market will always contain more information than any individual or government. Krugman, by the way, often writes about market failure. Finally, there is the problem of moral hazard associated with the payment of welfare benefits. Surpluses, which may arise when government fixes prices above the natural market rate, as supply will exceed demand. This is a common phenomenon on the political left. Subsidies, and other assistance, can lead to the problem of moral hazard. In the economic realm, that idea is very well defined.
Since we know that government decision making is inherently faulty, the strong presumption is that things should be left to the market.
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