Market Failures and State Intervention in the Economy

Posted on Oct 2, 2024 in Economy

Market Failures and State Intervention

Market Failures

Market failures are the negative consequences of market functioning that occur when it is not efficient in the allocation of resources. State intervention in the economy does not eliminate the negative effects of market failures, but only manages to reduce them.

Cyclical Instability

The Business Cycle: The business cycle is the sequence of more or less regular expansions and recessions of actual output around potential GDP.

Cyclical Instability: Cyclical instability directly affects the number and characteristics of workplaces in a country and thus lowers economic activity. During a recession, wages fall because companies reduce costs to cope with the economic downturn.

The Role of the State in Times of Recession:

• Non-intervention: Trusting that the market will emerge from the crisis without assistance and economic activity will expand.
• Intervention: Consuming or producing goods and services, thereby artificially stimulating economic growth.

Existence of Public Goods

Public Goods: Public goods are those that provide a benefit available to all, and from which no one is excluded, not even those who have not contributed to financing them. Consumption by one individual does not reduce, in whole or in part, the amount available for another individual.

Unprofitable Goods: These goods are not particularly profitable for investors, but are beneficial for the entire country.

Supply of Goods and Services:

1. Through own production: For example, the justice system.
2. Acquiring from private companies and then distributing them freely among the population: For example, partially funded roads.
3. Supply through acquisition: For example, housing.

Externalities

Externalities are the effects of the production or consumption of a good that are not reflected in its price and affect other economic agents other than those who have produced or consumed it.

Positive Externalities: These are effects that have a positive impact on society. For example, a factory that builds a road to improve its customer service also benefits everyone else who uses the road.

Positive Externalities in Production: If a farmer plants an apple orchard and a beekeeper places beehives nearby, the bees will extract nectar from the apple blossoms and facilitate pollination, increasing apple production. The honey producer experiences external benefits due to the effect on apple production.

Positive Externalities in Consumption: The consumption of education generates positive externalities because an educated population contributes to a better society.

Negative Externalities: These are effects that cause harm to society.

Negative Externalities in Production: For example, pollution in the case of a vegetable farm located next to a paper factory that dumps pollutants into the river. This is a harmful externality because the costs of vegetable production are negatively affected by the factory’s activity. These costs are not reflected in the price of paper.

Negative Externalities in Consumption: Smoking generates negative externalities for consumers who are near smokers.

The concept of externalities examines whether the market can effectively resolve the allocation of resources when the price of a product does not reflect its actual cost.

State Intervention to Address Externalities

• Establish a legal framework to provide public goods and services.
• Stabilize and redistribute income through monetary and fiscal policy.
• Intervene to ensure economic efficiency directly in the market mechanism.

Imperfect Competition

A competitive environment incentivizes businesses to produce better quality goods and adjust prices.

Benefits of a Competitive Environment:

• Stimulates innovation and technological progress.
• Allows access to the public to a greater number of goods and services at lower prices.
• Increases real wages of workers due to lower prices.
• Facilitates market access to new businesses and creates jobs.

The lack of competition, or a situation of imperfect competition, leads to abusive pricing practices and the fixing of the amount of product offered to the market without taking into account the needs of consumers.

The state intervenes in defense of free competition through:

• Antitrust service: Investigates, monitors, and records companies suspected of practices that restrict competition.
• Court of antitrust: Determines the existence or not of restrictive practices of competition prohibited by law.

Unequal Distribution of Income

The income distribution of a country basically depends on:

• Salary differences: If wages are significantly different, it implies a very unequal distribution of income.
• The distribution of wealth: The smaller the proportion of the population with access to the wealth of a country, the greater the income differences.

State intervention through economic policy seeks to stabilize the economy to minimize the negative effects of fluctuations and also aims at reducing inequalities in the personal distribution of income or geographic areas by establishing laws and measures to redistribute income.

Welfare State

The welfare state refers to the set of basic rights that every person should enjoy to have a dignified life. For many citizens who do not have a sufficient level of income to meet minimum standards, the state should provide these rights for free.

• Health: Every person is entitled to receive healthcare.
• Education: Education is compulsory until the age of 16.
• Housing: The Spanish Constitution states that everyone has the right to decent housing. The state can intervene through tax cuts, building subsidized housing, and providing housing subsidies.

Types of Benefits:

• Universal benefits: Offered to all people for free.
• Contributory benefits: People who have contributed to social security for a period of time can benefit from these.
• Social benefits: These include services such as dining rooms for people with greater social needs and limited resources.

Challenges of the Welfare State

The EU establishes policies to encourage countries to reduce public expenditure.

• Controlling public expenditure: Seeking a balanced budget, specifically a balanced general state budget.
• Labor market flexibility: Reducing redundancies and making dismissals easier.
• Control of inflation: Higher inflation creates uncertainty for forecasts and investments.
• Privatization of public enterprises: Eliminating the benefits and advantages of public enterprises by transferring them to private companies, thereby promoting competition.