Microeconomics: Role of Government in Correcting Market Failures


A proper market system is one that allows for the easy allocation of resources. It operates freely with the individuals who own resources determining how and what to produce using the opportunities at hand. There are, however, situations when the free market doesn’t work resulting in situations where the production and allocation of resources fails. This scenario is known as market failure; the free market fails to satisfy the wants of the society. The government may be forced to intervene to remedy the situation so that it can improve the performance of the economy and serve the interests of the community concerning the equal distribution of resources.

Correcting Market Failure

Market failure can occur due to the existence of monopolies in the economy. Companies with large market shares can merge and form monopolies which promote unfair competition in the market through morally wrong pricing thus restraining trade. This behavior demonstrates a lack of integrity because it locks out other competitors from enjoying the market share. The government can correct this failure through passing legislation that regulates the activities of monopolies. The Sherman Act enacted in 1890 by the US Congress prevents companies from forming monopolies that will lock out competitors (The Antitrust Laws). This law was put to good use in 2011 when AT&T sought to buy T-Mobile. The move was blocked by the Department of Justice because they saw the potential creation of a monopoly that would reduce competition in the telecommunication sector.

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Governments can use taxation is a means of correcting a market failure in three ways. First, whenever unhealthy price wars exist, taxation helps to allocate resources fairly by influencing the prices of goods and services. It brings all companies on a level playing field thus promoting healthy competition. Secondly, governments can use taxation to provide relief to businesses that want to venture in a particular market where resources are scarce (Guenther 6). A market failure may occur when a certain sector is facing decline, and the stakeholders opt out. It results in unemployment and also deals a blow to the country’s economy. The government can introduce tax relief and other subsidies to encourage new entrants to the market or to motivate those who are in it to stay on. Thirdly, taxation helps to correct market failures caused by negative externalities. For example, the climate change levy in the UK forces companies to take responsibility for the damage they cause to the environment as they use energy sources that release greenhouse gasses into the atmosphere (Letcher). This tax is beneficial to the environment and the community as a whole because it encourages business owners to move towards more environment-friendly sources of energy.

The free-rider problem has the potential to cause market failure. These are people who benefit from services but don’t pay for them. The free market cannot benefit from providing public goods because of minimal profits, and therefore many shy away. This action results in market failure. It is the responsibility of the government to provide public goods to correct this. The government can do this through taxing its citizens for the use of public spaces, sewerage services, street lights, roads, and so on. These taxes ensure the continual supply of services without putting pressure on the free market.

Does Government intervention work?

On paper, the interventions mentioned above seem like the best way to cure market failure. There are, however, problems faced during the implementation of these regulations that lead me to conclude that the government intervention doesn’t work. For instance, dealing with the free-rider problem can result in a tax burden on individuals. The imposed taxes could be eating into an individual’s income which may reduce his or her ability to enjoy the services provided. Providing tax relief comes at a cost to the government because it loses money as it tries to help businesses. Besides, the business owners may decide to pocket the extra money instead of furthering the government’s agenda. When it comes to dealing with negative externalities, the government faces evaluation and implementation problems. How does the government measure the tax percentage handed out to a company accused of emissions? This situation presents a gray area in the correction of this failure. It is also difficult for the government to follow up and enforce the regulations that it lays out. Just because the lawmakers pass a policy, its success on the ground is not guaranteed.


To conclude, the government can, to an extent, solve problems in the free market. However, it is impossible for the government to do this competently because markets are naturally imperfect. Loopholes that work against the efforts made will always exist.


Works Cited

“The Antitrust Laws.” Federal Trade Commission, https://www.ftc.gov/tips-advice/competition-guidance/guide-antitrust-laws/antitrust-laws. Accessed 23 Mar 2017.

Guenther, Gary. “Federal tax benefits for manufacturing: current law, legislative proposals, and issues for the 112th Congress.” Congressional Research Service, 2012. Retrieved from https://fas.org/sgp/crs/misc/R42742.pdf

Letcher, Mark. “The Climate Change Levy (CCL) – A Quick Guide.” Climate Works, 1 Jun. 2013, http://www.climate-works.co.uk/blog-entries/the-climate-change-levy-ccl-a-quick-guide/