Market Failure and Government Intervention:

Governmental intervention is required when there is market failure. Market failure means when the market mechanism i.e., market  exchange becomes not operative between the buyer and the seller.  In the case of public goods due to its (a) non- rivalness in  consumption and (b) non-excludability in nature free rider problem arises.

Each individual thinks that why should he pay for it; if a public good will be provided, he cannot be excluded from its consumption and  even if he consumes he does not take away the share of others so nobody can object to his consumption.  Moreover the  provision of the public goods does not depend upon his payment only.  Public goods will not be provided when others do not pay.  If  others will pay as such the public goods will be provided even if he does not pay.  This type of consideration is generally true for  everybody so nobody is willing to pay. No private sector will come forward to produce or provide this type of goods.  From the point  of view of social welfare the government needs to provide or produce public goods through its budgetary policy allocating public  expenditure.  Besides this, in the case of public utility services since natural monopoly prevails as plant capacity exceeds public demand and also it conforms to diminishing cost industry the government has to intervene. In this case for government sponsoring  firms to supply services to the public, charging of   Marginal Cost Pricing at the same time to fulfill general equilibrium conditions for  achieving maximal social welfare will result in loss to the firms.  In the process to motivate these firms government may have to  disburse huge amount of subsidies against firms' resulting loss.

In the case of certain goods there is under consumption.  Let us take the case of education and health.  These are known as merit  goods.  When a person gets educated he gets benefits of being educated and it is the personal benefit, which is in the nature of  private goods for him.  In addition to this others also get some benefit i.e. positive spillover from the person being educated. Keeping  in view the positive spillover aspect there is the need of educated or qualified persons up to a certain level.  Persons may not be  willing to pursue their education from the social perspective due to the prevailing socio-economic costs.  This results in under  consumption and the government has to check it through motivating people and it directs allocation of public expenditure in terms of  scholarship or incentives etc.  In the case of merit goods there is the blending of private and public goods characteristics.  These  goods are so meritorious that the government has to come forward for its provision and production supplementing and facilitating to  the amount produced or provided by the private sector.

Role of the government also covers the correction of over production of those goods, which lead to the negative spillover for the  society in terms of pollution, environmental cost and other types of resulting social cost. Government introduces restriction and imposes taxes to control production of these types of goods known as non-meritorious goods.