Reasons for government intervention in markets

Economics AS · Government microeconomy intervention. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Free markets do not always give the best result for society, so governments step in. There are three main reasons at this level.

First, public goods such as defence are non-excludable and non-rival. People can use them without paying (the free rider problem), so private firms cannot make a profit and the market does not provide them.

Second, merit goods such as education are under-consumed and demerit goods such as cigarettes are over-consumed, because consumers lack full information about the true benefits and harms. Third, governments control prices: to keep essentials affordable, to protect the incomes of producers such as farmers, and to make prices more stable.

Rules to remember

Public good: non-excludable (non-payers cannot be kept out) and non-rival (one person's use does not reduce the amount left for others)
Free rider: someone who benefits from a good without paying for it
Public goods are not provided by the market, so the government provides them and pays from taxation
Merit good: better for people than they realise, so under-consumed in a free market
Demerit good: more harmful than people realise, so over-consumed in a free market
Maximum price: set to keep a good affordable for consumers
Minimum price: set to protect producers' incomes, or to cut consumption of a demerit good

Common mistake

Students call any good supplied by the state a public good. Health care and education are merit goods: people can be excluded and one person's use does reduce what is left for others.

Worked example

Why will a private firm not provide street lighting in a town, even though residents value it?

Street lighting is non-excludable: the firm cannot stop people who have not paid from using the light.
It is non-rival: one person's use does not reduce the light available to others.
So each resident can be a free rider and wait for others to pay, and the firm cannot collect enough revenue to cover its costs.

Answer: Street lighting is a public good, so the market does not provide it and the government provides it from tax revenue.

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