800 words

Q. Using examples, assess the success of government policies implemented to reduce market
failure in the Australian economy.
Things to include:
- Definition
- Government policies (2-3)
- Types of market failure
- Judgement of policies (conclusions based on evidence)
- Evidence (statistics, models)

Market failure is a common economic phenomenon that can cause significant social costs and
economic consequences. These consequences include environmental spillovers and
externalities, inadequate provision of merit and public goods and services, and volatile
fluctuations in the business cycle. The Australian government employs a range of policies to
solve or alleviate these issues, such as fiscal policy in the form of taxes, subsidies and public
expenditure to redistribute income, and monetary policy, in the form of the cash rate set by the
Reserve Bank of Australia (RBA). These policies vary in effectiveness but have generally been
successful in reducing market failure in the Australian economy.

Australia operates under a mixed economic system. This means that it is subject to the market
forces of supply and demand and fluctuations in economic activity in the business cycle that can
create market failure but is also managed by government intervention in the form of policies.
Fiscal policy is the use of taxation and government expenditure to stimulate or dampen
economic activity, while monetary policy refers to the Reserve Bank of Australia’s (RBA) actions
to affect money supply and interest rates in the economy. Market failure refers to the inefficient
allocation of resources in an economy. An example is when only the private, not the social, costs
and benefits are considered in a transaction, leading to externalities experienced and paid by a
third party.

Externalities are a significant type of market failure. A graphical representation of a negative

externality in production is shown in Figure 1. The PMC supply curve represents the private
marginal cost of production, while the SMC represents the social marginal cost, which is the true
cost of production. This cost may be in the form of pollution and greenhouse gas emissions,
adversely affecting the environment and the wider society. It would be most efficient to
internalise the externality, moving the price up from P1 to P2. This would increase the
opportunity cost of production and put pressure on the producer to reduce the quantity
produced from Q1 to Q2, which is in the best social interest.

Figure 1
Though the Australian Government does not currently have a carbon tax to do this, it has
implemented an Emissions Reduction Fund (ERF), under which the carbon credit unit (ACCU)
scheme effectively subsidises firms’ investment in reducing or offsetting carbon emissions. The
Government’s Clean Energy Regulator states that it has issued 6.2 million ACCUs as of 30 June
2023, so the scheme has encouraged significant participation, however, it has been deemed a
“failure” by a Guardian article, declaring that “these projects were often not reducing their
impact on the climate as they claimed.” Overall, though, the Climate Change Authority claims,
“The ERF has been successful in incentivising low cost abatement from the agriculture, land and
waste sectors”. Therefore, its success is difficult to assess but is potentially substantial due to its
popularity. Additionally, the Australian government charges excise tax on demerit goods,
considered detrimental to society or the consumer, to reduce negative externalities in
consumption. Nonetheless, around 8 in 10 Australians consume alcohol each year and 12% of
the Australian population smoke tobacco daily, so this tax is limited in its intended effect.

Market failure may also occur when the market fails to provide essential public goods and
services or does not produce and consume sufficient quantities of merit goods. Public goods are
non-excludable and non-rival, meaning that they cannot be restricted to those who pay for them,
encouraging free riders, but are not degraded from consumption, unlike common resources,
which are rivalrous. Thus, they are unprofitable and usually not provided by private firms. Merit
goods have positive externalities that the consumer does not experience, and therefore tend to
be under-consumed.

National defence is a public good that is provided by the Australian government, as it is a

collective want that benefits everyone in the community. Fiscal policy in government taxation is
effective in collecting revenue from the public to fund the provision of defence, accounting for
around 2% of the federal budget. In the case of merit goods such as education, the Australian
government both reduces the cost of providing the service by subsidising schools and directly
provides government schools for the public to attend for free. Education accounted for 7.2% of
government expenditure in the 2024 federal budget, with $11.3 billion to government schools,
$9.9 billion to Catholic schools, $8.1 billion to independent schools, and another portion for
higher education. This combination of subsidisation and provision of merit goods successfully
offers a variety of options to the public to increase the uptake of merit goods.

Lastly, the Australian economy is subject to the business cycle, alternating between phases of
high and low economic growth and activity, called booms (expansions) and busts (contractions).
Without government intervention, the cycle can be very volatile. A long contractionary period
can lead to recession, which can lead to unemployment and a decrease in wages, production and
consumption causing slow economic growth and lower standards of living. Conversely, although
a long boom period boosts economic growth, it can also cause high inflation, undermining
nominal wage growth and hence purchasing power.

The Australian government implements macroeconomic policies such as fiscal and monetary
policy to smooth fluctuations in the business cycle and maintain a stable rate of economic
growth. For example, the government may budget a deficit, in which spending is greater than
taxation, in a contractionary period, to inject more money into the economy and stimulate
economic growth. Conversely, it may budget a surplus, in which taxation exceeds spending, to
reduce net income levels and dampen economic growth. Monetary policy by the RBA,
particularly the use of the cash rate to influence interest rates, is also key to controlling inflation.
The cash rate is the average interest rate charged on overnight loans to commercial banks by the
RBA, which influences commercial interest rates in the short term. High interest rates lower
inflation as lending is more profitable than borrowing, discouraging consumption, and vice
versa for low interest rates. For example, during the Global Financial Crisis in 2007-2009, the
Reserve Bank lowered the cash rate from 7.25% to 3% in response to the sharp economic
downturn, reducing borrowing costs and increasing consumption, helping to reduce its severity.
Generally, these policies are highly effective in helping the Australian economy achieve
sustainable growth in the short and long term.

Overall, the government policies used to manage the above types of market failure in the
Australian economy are fairly effective on average. These policies range from stabilising
economic growth to providing goods and services and subsidising socially beneficial activities
and investments. In the absence of these policies, the economy would be vulnerable to market
forces, fluctuations, and the unsustainable self-interest of individuals.