That could include screening the quality of food, requiring approval of pharmaceuticals, or demanding training and licensing before providing a service. That makes them unpopular in places that value freedom.Ī less extreme version of government control is through regulating a given activity. However, prohibitions are drastic actions that infringe on personal liberty. Examples include selling addictive drugs, prostitution, and plastic bag bans. First, the government can simply outlaw an undesirable action. There are a few ways that government intervention happens. When the market fails to achieve the best outcomes, the government sometimes steps in to try to fix things. An example of this would be rent control leading to a shortage of available quality housing. However, if it’s the regulations themselves that are causing the negative result, removing those rules would be the solution. For example, if the free market leads people into drug addiction, the government can make that product illegal. If the market drives the economy in a direction that people don’t like, regulations can steer the market toward a better outcome. For instance, a carbon tax would increase the cost of products that cause pollution, thereby factoring the cost of pollution into the choices consumers make. In the case of things like pollution, in which externalities cause the market to reach an undesirable outcome, taxes can incorporate the external impacts of pollution into a firm’s or individual’s decision-making. If the failure is a result of self-interested people overusing a resource, privatizing that resource might work. For example, an insurance company might require a physical before writing a life insurance policy. If the market fails because of information asymmetry, then disclosures and due diligence can help. The solution to a market failure depends on its cause. But the government sometimes goes too far, preventing the market from working the way it should. In those situations, the people might want the government to intervene with public policy that improves the state of affairs. There are several reasons that the free market can break down. When that happens, it’s called a market failure. In reality, the free market doesn’t always result in the outcomes that the public wants. This theory is the idea behind capitalism. In theory, the laissez-faire (hands-off) government can allow the economy to function without any economic policies, and things should work out just fine. And competition makes sure prices balance what buyers want and how much it costs a seller to produce.Īdam Smith (the father of classical economics) described it as though an invisible hand guides the market to an efficient outcome. Rational entrepreneurs make what people want to buy. Self-interested buyers tell suppliers what to make by buying the products they want. In theory, allowing buyers and sellers to set prices and production levels should result in wanted outcomes. Classical economic theory would imply that these types of failures shouldn't happen. A market failure is what economists call a situation in which the market doesn’t reach the best possible outcome on its own.
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