Government Intervention: Addressing Market Failures

Economic Cycles

Fluctuations in economic activity, characterized by the expansion or contraction of output and employment in most sectors of the economy.

• Expansion: Increases GDP and creates more jobs.
• Recession: Economic resources, workers, and factories sit idle.

Externalities

Situations arising when the activity of a company or a consumer creates external effects that impact third parties. These may be positive for society (social benefits) or negative (social costs).

• Consumption Externalities

  • Positive: Examples include healthcare and education, where the state provides grants to encourage consumption.
  • Negative: Examples include tobacco and alcohol, where the state imposes sanctions and taxation to reduce consumption.

• Production Externalities

  • Positive: Research & Development (R&D) and innovation, which require training and support through state aid and subsidies.
  • Negative: Pollution, addressed through measures such as fines, taxes, and eco-taxes.

Public Goods

Pure Public Goods

A type of good where consumption is indivisible, and no person can be excluded from its benefits. Therefore, it must be offered by the public sector, as no private company is interested in producing it since they cannot charge a toll.

Free Rider Problem

Individuals wait for someone else to pay for a public good or service, benefiting from it for free without contributing to its cost.

Lack of Competition

A type of market in which one or more companies are very powerful, enabling them to influence the price and quantities of goods and services offered.

Consequences:

1. No innovation.
2. Hindrance to new technologies.
3. Increased prices.

Equity

The principle that people in the same or similar situations should pay the same taxes and receive the same types of benefits (Horizontal Equity). Conversely, people who enjoy greater well-being should pay more taxes and receive fewer benefits than those who do not enjoy this well-being (Vertical Equity).

Functions of the Public Sector

1. Regulates Economic Activity

   The state sets the rules that organize economic activity. Agents do this through laws and regulations (e.g., those that regulate private property).

2. Produces and Provides Goods and Services

   The state produces public goods and services. Most education, healthcare, and police services are provided by the state. It may also purchase goods from other companies to offer (e.g., roads) or subsidize the cost of certain goods and services, such as university education or public transport.

3. Establishes Taxes to be Paid

   The state has public expenditures that are financed through taxes. Distinct tax systems, procedures, and rules help to finance public spending. Systems can be progressive (more income leads to proportionally more taxes) or regressive (less income leads to proportionally more taxes).

4. Redistributes Income

   The objective is to reduce inequalities in the distribution of personal income or between geographical areas. The state establishes progressive tax laws, minimum wage laws, unemployment benefits, and other measures to achieve equity.

5. Stabilizes the Economy

   The state plans and takes action to ensure that economic fluctuations do not lead to unemployment or price increases.