Public Sector Functions and Market Failure Mechanisms
The Public Sector
The Public Sector refers to public administrations and therefore comprises the set of institutional units whose primary functions are: one, to produce goods and services not intended for sale, but provided without charge to society; and two, the redistribution of income and wealth.
Market Failures
Market Failures, also known as "bugs in the assignment," are situations where the market mechanism does not generate efficient allocations in the Pareto sense. The principal market failures are linked to:
- Public goods
- Monopolies and weaknesses in competition
- International externalities
Public Goods
Public goods have two characteristics: they are not rivals in their use and are not excludable under the price mechanism. There are goods that are rival in use (such as a park). Many of these goods are usually non-rival and also non-excludable through the price mechanism (public goods).
Monopolies
Monopolies are situations where a company dominates the market by raising prices above the social optimum. The public sector intervenes by socially regulating these markets.
Negative Externalities
Negative externalities occur when the activity of an individual or a company creates a cost or a welfare loss for the rest of society without compensating them for it. Thus, the market tends to produce more negative externalities than the socially optimal amount.
Positive Externalities
Positive externalities appear when the activity of an individual or a company generates a series of positive effects and benefits for the rest of society without being rewarded for it. Consequently, the market tends to produce too little of these activities.
Equity Failures
Equity Failures occur when the assignment of resources or rents generated by the free market, even while being efficient, is considered inequitable and socially unjust. There are different focuses on what should be the criterion of distributive justice:
- Total equal score: All individuals receive the same income level.
- Equal opportunities: Ensuring a fair starting point for all.
- Operating rules: Adherence to the rules of market economies.
The Welfare State
The Welfare State provides social protection for individuals, ensuring equal opportunities and helping the poorest and most disadvantaged groups of society. There is no agreement on the scope and intensity that public sector aid should have; therefore, different models of the welfare state exist. Compared to the United States model, European models offer high social protection and are therefore very interventionist.
Fiscal Policy
Fiscal Policy is the set of decisions made by the government on the volume and composition of public expenditure and revenue. Fiscal policy can be used not only for equity but also to solve macroeconomic stability failures that originate from aggregate goods and services.
Public Deficit
The Public Deficit is the difference between public expenditure and revenue. The public deficit can be financed by issuing money or by issuing forms of financing such as public debt. Both forms of financing generate a series of economic problems such as inflation or crowding out, which is why governments should control and regulate their deficit levels.