Economics_-_Government_Intervention_in_Market_Failure

Under a lassiez faire system or an economy run by the operation of free market forces, the desired social and economic outcomes are not always achieved. When these outcomes are not achieved, it is known as market failure. Market failure includes severe fluctuations of economic growth (recessions and booms), high inflation, unfair income distribution and monopolies. In response to the insufficiency associated with the various types of market failures, government intervention is required. Shown on the left is the business cycle determining the economic growth rate of a certain economy. Removing all the factors, the economic growth rate becomes a straight line trend however as external factors cannot be removed completely it becomes a curve with A being a Boom period and B being a Recession period. As shown, there is a severe fluctuation from A to B but with government intervention, A can be reduced to C and B can be increased to D. The government stabilizes the economy whilst sustaining the economic growth rate through the implementation economic stabilisation policies such as monetary and fiscal policies (marcoeconomic policies) and competition and trade policies (microeconomic policies). The Global Financial Crisis is a recent economic disaster brought upon by the subprime mortgage lending in the US and caused the provision of credit to dry up around the world. Firms slashed their production costs and ran down inventories. The businesses in Australia ran down their stocks by $ 3.4 billion, the largest fall in record. Consumer and business confidence plummeted causing Australia to enter a recession as consumers began to save rather than spend. Without government intervention, Australia’s condition could be on the verge of deflation, which can have negative social/ economic outcomes. The loose monetary policy or downwards pressure on the interest rate between the Sept/ 2008 to March/2009 period caused interest rates to fall from 7% to 3.25%. Low interest rates means less taxation thus more disposable income (DI = personal income – personal tax) is left with the consumer, which leads to a increase in the marginal propensity to consume (c1). As autonomous consumption (c0) remains the same, there is a rise in the total consumption of the economy/ economies income (EI = co + c1DI) thus a rise Aggregate Demand (AD) from AD1 to AD2 shown in the Keynesian Cross diagram. Not only did the government attempt to stimulate the economy through a loose monetary policy, they also incorporated the use of fiscal policies by injecting resources into the economy. The $10.4 billion stimulus package was used to stimulate the economy with $8.7 billion going to pensioners and low income earners who have a higher propensity to consume. As the economic growth was minimal, due to paranoia, after the first stimulus package, the resources that leak out due to consumer savings must be counter balanced by the government expenditures thus the need for a second stimulus package until positive economic activities were experienced. This $ 42 billion dollar package was aimed at the construction of new infrastructure. The government intervention during this crisis had positive results causing unemployment levels to peak at 8.5% rather than at 10% and the GDP growth in the March Quarter was 22% above the October level in 2008. However the government’s expenditure has put Australia in a foreign debt of 17.9% of GDP or $163.8 billion (2009) Additionally market failure can often happen in the market, where there can be substantial amounts of market power abuse. These usually occur in monopolies, where the dominating firm can exploit its power over the economy through price discrimination, which reduces consumer sovereignty but also eliminating competition. Government intervention is needed to prevent these situations from happening and this is done through microeconomic policies. The prevention of the exploitation of consumers is done through the ACCC (Australian Competition and Consumer commission established in 1995) and the Trade Practices Act (1974). The Australian government’s decision to privatise Telstra, a giant Telco firm, was to allow new competitors to enter the market such as Optus and Vodafone. However how the govt. approached this problem was seen as a mistake and a recent $11 billion deal between the government and Telstra in order to rectify this mistake. It was seen as a win – win situation where the governments could remove the substantial market power from Telstra and the company in return would obtain an 11 billion dollar profit for lending NBN (national broadband network) its infrastructures. Telstra also lost a court case, dealing with the access prices, against the ACCC in 2008. These two factors were significantly important to the government’s $43 billion microeconomic reform to nationalize a broadband network. Due to the government’s privatisation act, Telstra held 45% of the market share compared to the 35% held by Optus, the next biggest competitor. They also held annual revenue of $21 billion, 3 times the size of Optus, and 2/3 of all industry revenues. But also through the government intervention (the ACCC and the 11 billion dollar deal), Telstra has lost significant amounts of market power rendering them unable to exploit consumer sovereignty. As they no longer hold this power, they have “scrapped” their aim to maximize their profits but instead to win back market share from their competitors as clearly seen when Telstra dropped their 25 GB product from $89.95 per month to $49.95 per month. Thus clearly seen, government intervention can produce both positive (demonopolisation) and negative results (Telstra abusing prices). Clearly evident within the two recent contemporary examples, government intervention has been both effective and ineffective as some interventions have allowed a monopoly to abuse its power within prices. However without government intervention, market failure could happen as a result of other factors such as economic activity. Therefore it is crucial that the governments should step in to protect the consumers and the economy. These recent microeconomic and macroeconomic reforms have fixed/ prevented severe market failure whilst maintain a stable economic growth.