Policies to correct market failure
| English | Chinese | Pinyin |
|---|---|---|
| subsidies | 补贴 | bǔ tiē |
| indirect taxes | 间接税 | jiàn jiē shuì |
| negative externalities | 负外部性 | fù wài bù xìng |
| positive externalities | 正外部性 | zhèng wài bù xìng |
| regulation | 管制 | guǎn zhì |
| tradable permits | 可交易许可证 | kě jiāo yì xǔ kě zhèng |
| state provision | 政府提供 | zhèng fǔ tí gōng |
The government's toolkit for market failure
- Once you've spotted a market failure, the question is what to do about it — tax it, subsidise it, regulate it, or provide it directly?
- Each tool has strengths and pitfalls; the skill is matching the policy to the failure.
To correct a negative externality, a government would typically use a:
A tax raises the price and cuts the over-produced quantity toward the optimum.
Subsidies are used to encourage goods with positive externalities, like vaccines.
Subsidies lower price and raise consumption of under-provided merit goods.
Taxes and subsidies 补贴
- Indirect taxes 间接税 on goods with negative externalities 负外部性 (carbon tax, sugar tax) raise price and cut output toward the social optimum.
- Subsidies for goods with positive externalities 正外部性 (vaccines, public transport) lower price and raise consumption.
A tax set to the external cost shifts the market toward the social optimum — closing the welfare loss.
When a market fails
An externality (like pollution) means the market price ignores a real cost — output ends up above the efficient level. Add the external cost to see the gap.
Tradable pollution permits work by:
A cap-and-trade system limits total emissions and prices them via a permit market.
Regulation 管制, permits and provision
- Regulation: rules and limits (emissions caps, bans, age limits).
- Tradable permits 可交易许可证: a cap on total pollution, with permits firms can buy and sell — a market-based fix.
- State provision 政府提供: the government supplies public/merit goods directly (defence, schooling).
Income inequality: informal settlements sit close to wealthier districts in many cities
Match each policy to the failure it tackles.
Tax curbs negative externalities; subsidy boosts positive ones; provision supplies public goods.
Evaluating policies
- Judge each by effectiveness (does it hit the optimum?), cost, administrative feasibility, and unintended consequences (e.g. a black market, or government failure).
No policy is free. Taxes are hard to set exactly; subsidies cost the taxpayer; regulation needs enforcement. Always weigh the cure against its own costs.
A progressive tax takes a higher rate from higher incomes
A policy can backfire through government ______ (unintended consequences that worsen welfare).
Government failure: intervention that does more harm than good.
You've got it
- tax negative externalities; subsidise positive ones; toward the social optimum
- regulation, tradable permits, and state provision are further tools
- evaluate by effectiveness, cost, feasibility and unintended consequences