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Market Intervention

Governmental intervention in the free market operation become necessary whenever there is “market failure”. Market may fail due to a number of reasons.

First, there may be large scale economies of scale, as a result of which the long run firm may enjoy cost advantage internal to the firm. Other firm may not have any access to such cost advantages. Reaping the internal economies of scale, prodding larger and larger volume, the firm may grow in size and become “big” enough to dominate the market and create monopoly tendencies and thus the forces of competitive market may fail to direct optimum resource allocation.

Second, the allocative efficiency may also be handicapped c because of presence of externalities. The free market price mechanism, left to it, may not ensure perfection because price often take care of private cost rather than social costs. Guided by price and profitability considerations, a factory may produce a lot of smoke, a health hazard involving huge ‘social cost’. Such externalization of internal diseconomies of scale does hamper social good and welfare, but market mechanism cannot do anything about it. Market fails to correct such situation.

Third , prices and profits together do not always guarantee the production of public goods and services like hospitals, parks, roads and bridges, public transports, because such production involves huge investment and high overhead cost; private investors do not venture to undertake such projects involving high risk and less return. Similary, guided by commercial profitability rather than social desirability considerations, the free market may encourage the production of essential drugs (merit goods). Thus, the market fails to ensure social welfare, i.e., ‘maximum good for maximum number’.

There may be many more cases of market failure. The present section intends to throw light on the forms and techniques of governmental intervention toward correcting such situation of ‘market failure’. We may specifically refer to fiscal intervention by way of (a) imposition of taxes (b) grant of subsidies (transfer).