Why Governments Intervene Free markets have often been idealized In the US, and have become a dominant tool for trade and distribution of goods and services, There have been multiple waves of government regulation and deregulation of the market in US history. Each of these trends have been grappling with the central question of how sufficient markets are at satisfying our goals. In theory, free markets are fair and efficient at distributing goods and services. In reality, however, government must intervene in the marketplace for two overarching reasons.
First, because in practice free markets left to themselves are not always fair and efficient. And second, because fairness and efficiency are not our only goals and values as a society. Market Failures The hypothetical purely free-market model is what Whimper and Paving call the Idealized Competitive Model. It is a starting point from which one can examine the shortcomings off pure free market system. The model assumes that all individuals have perfect information of goods, services, and exchanges, and that they make rational trade decisions to maximize their own utility.
Firms, acting to maximize refits, are In perfect competition with one another, with many buyers and sellers In any given market. Individual firms and Individuals are able to move around freely, and all costs and benefits of all exchanges are accounted for in the prices. The overarching ideal and goal of this model is for Parent efficiency, in which the allocation of goods and services optimizes social surplus (the combined amount of benefits felt by producers and consumers in an exchange).
In other words, a particular allocation of goods that is Parent efficient cannot be modified without making at least one participant worse off (Whimper and Paving p. 6). Economically speaking, the Idealized free market model Is perfectly fair and unbiased, aiming to maximize all individuals’ social surplus. Clearly, the ideal of private free markets is for an efficient distribution of goods and services through a fair and competitive market framework. In economic terms, the idealized competitive model breaks down in four general ways, called market failures.
Beyond these market failures, the social and Ideological shortcomings of this model are discussed in the following section. Public goods are contrasted with private goods In that they are “nervously In institution, incalculable in use, or both” (Whimper and Paving p. 73). These are goods that are not efficiently allocated, if at all, in a free market. Non-calculability, often called an open-access resource problem, is a situation in which consumers will overuse the resource without investing in it (Whimper and Paving p. 78).
A non- rivalries good is one that, although it may be clubbable, can provide large supply without overcrowding. For example, a non-crowded toll bridge has a supply much higher than demand. In this case, If the bridge Is privately operated and drivers are harmed a fee for its use, the result would be underestimation and the social surplus would no longer be maximized. Finally, a purely public good such as national defense is non-clubbable and non-rivalries: a highly-valued service that benefits everyone in the country, whether they pay for it or not.
Members can avoid paying and still receive the benefits, thereby posing a free-loader problem. It Is usually the therefore be provided by government. A public good that is critical to the free market is the government’s enforcement of contracts and protection of wealth. In order to make individuals feel safe in making economic transactions, it is necessary for government to protect private property and make sure that participants uphold their contracts. Externalities are impacts created by an exchange that affect individuals who did not consent to or have any part in the exchange.
Such impacts can be positive or negative, but are not adequately valued in the exchange and therefore represent a social cost or benefit that is not optimized. The result is an unfair distribution of impacts that does not maximize social surplus. Whimper and Paving call externalities “missing market” (p. 92). It is feasible to imagine externalities being accounted for by a private market, in cases where, for example, an externalities is manifested into a change in land value. However, these cases are exceptional.
Governmental must typically step in to value externalities, such as charging fines for polluting industry, in order to account for social costs and benefits. Natural monopolies are cases in which production costs, infrastructure, and demand structure lead to a single monopolizing firm producing the good at lower cost than any other arrangement. Under such situations, firms will tend to over- charge and under-supply, causing a reduction in social surplus and an inefficient distribution of goods.
A lack of competition is a fundamental violation of the idealized market assumptions. Little or no competition leads to inefficiencies of production and operation (Whimper and Paving p. 102). Furthermore, natural monopolies give an unfair and non-competitive advantage to firms that have entered the industry first. In cases of natural monopolies, government must typically regulate private industry in an attempt to maximize surplus, or, alternatively, government may revived the good or service publicly.
Stone concisely describes the inefficiency of information asymmetries: “in order for exchanges to yield the best situation for everyone, buyers and sellers must have complete and accurate information about the available alternatives” (p. 72). Perfect information in the idealized competitive model is central to fair, competitive, and efficient distribution. In an exchange, a consumer cannot maximize his or her consumer surplus without symmetric information about the quality of the good. Government must intervene to set standards of information disclosure.
In the case f tobacco companies choosing to mislead consumers about the health consequences of cigarettes, government regulated the use of the terms “mild” or “light” (Stone p. 72). While other factors such as addiction play strong roles here, without government intervention the consumers’ misinformation would lead to high unintended social costs. Values In her book, Deborah Stone contrasts two models of society. One is a hypothetical fully-rational and purely market-based society which she calls the rationality project that shares many of the same idealized qualities of the Idealized Competitive Model from Whimper and Paving.
In this model, society members make decisions with perfect information and with perfect rationality. Decisions are made through straight-forward selections of which option will maximize their independent self- value-based model of a society which she calls the polis. One of the dominant differences between these two models is the importance of values and ideologies in the polis. She outlines five values that, although they can be ambiguous in their interpretations, are held at least to some degree by people and societies.
The first two, equity and efficiency, are values that might theoretically be satisfied, at least in art, by attributes of the free market. However, for reasons of market failure discussed previously, government intervenes when these values are not satisfied. In fact, the reason these are considered failures of the market is that fairness and efficiency are values that are deemed important enough to maintain in society. The last three, welfare, liberty, and security, are values that not supplied by or a part of the free market model, and yet are demanded by society.
It is due to this discrepancy that government must intervene. First, Stone describes efficiency as a value that we do not want “for its own sake, UT rather because it helps us attain more of the things we value” (p. 63). It is because of these wants that many people turn to free markets, lauded for their ability to efficiently allocate goods and services. As described earlier, market failures can lead to inefficiencies in distribution and in social surplus, and therefore depend on government corrections.
The value of efficiency may be a reason for people’s distaste for government services, which, lacking competition, has less competitive incentive to maximize efficiency. However, it is clear that society holds more values than Just efficiency. Equity is described by Stone as a question of who is to be treated equally, with regards to what, and how that equity is to be manifested (Stone p. 42). The attribute of fairness in free markets is a form of equity. In the perfect competition model of free markets, any two individuals with equal resources have equal opportunities to trade and maximize their utility.
The system is blind to anything but differences in resources. As was discussed previously, this ideal of equity and fairness in the free market does not exist in reality. Information asymmetries exist that can mislead individuals into making an inefficient exchange. Social biases can cause preferences in trading and hiring that are economically irrational. For this reason, government has implemented anti-discrimination regulations in the marketplace. Natural monopolies reduce competition and give unequal chances to potential competitors to enter the market.
In a purely free market system, wealth alone would determine what policies did exist. As a democratic society, we have decided that equality of voting power, regardless of economic status, is important enough to make into law. Whimper and Paving call “political participation” an important value to consider next to efficiency (p. 55). Whimper and Paving write that “respect for human dignity seems to Justify public policies that ensure some minimum level of consumption to all members of society’ (p. 144). In other words, all members of society deserve some basic level of welfare, some minimum on which to live.
Ambiguities exist between what is considered a necessity and a desire. And, in a free market, giving basic necessities to those who cannot pay for them is inefficient. However, the reality of the polis is that “we care about others and want others to care about us” (Stone p. 79). Social barriers Furthermore, accidents and disasters can strip a person’s wealth and capabilities. In these situations, government welfare becomes an aspect of security as well. Stone gives a variety of concepts of security.
Security can mean a government safety net in case of disasters and accidents. The food stamp program is designed to provide temporary relief to people as they regain their footing. Many might argue that these insurance-like scenarios are best left to the private sector. However, security on a national level becomes more of a public good such as national defense. As mentioned previously, government protection of private property and enforcement of contracts are issues of security that are not only valued by society but necessary for the private market to function.
The final value that Stone presents is that of liberty, perhaps the most abstract and ambiguous of this list of values. Whether taking a Hobnails or a libertarian view on liberty and government, the value of liberty is held universally in some form or another. The notion of government protecting liberties is tightly related to issues of security and welfare. By providing basic protections and safety nets, government an allow for the protection of certain, if not all, individual liberties.
In what some see as a counterintuitive tradeoff, individuals give up certain liberties to government in exchange for security, welfare, and protection of other liberties. Conclusion While the degrees to which they are upheld, and the ways in which they are interpreted varies tremendously over the sociopolitical spectrum, the list of values that Stone outlines are commonly shared ideologies of society. The fact that we do value efficiency and fairness is one explanation for our admiration of the free market yester.