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Options available for governments in overcoming market failure resulting from negative externalities of alcohol


Market Failure refers to the failure of the price mechanism to achieve an optimum allocation of resources. Negative Externality is a market activity that negatively affects other people. Demerit Good is a good that is socially undesirable. For the demerit good of alcohol, the negative externality is drunk-driving that causes third-party death.

An example of the government’s success in overcoming the failure of markets to take account of negative externalities is in education. Only in the long run, for addressing the alcohol problems, non-market based solutions such as education program or funds can be one of the most effective means of reducing the negative externality of alcohol such as drunk-driving or addiction. For example in March 2014, the Northern Rivers school was successful in educating the students about the dangers and the consequences of dealing with drugs and alcohol use on adolescent minds and bodies. This in return dissuaded students from intaking high level of alcohol, thus improving the overall well-being and health of the students.

To take account of the negative externalities of alcohol, governments should decrease demand for alcohol. In addition to educating students about the dangers of alcohol, if the government decreases advertising on alcohol, another non-market solution, it will successfully decrease the demand for alcohol. This occurs because when advertising is decreased, less attention is brought to alcohol and less demand is inspired by the total advertising for alcohol. This then decreases the quantity demanded for the same price, and partially takes account of the negative externalities of alcohol from consumption such as drunk driving and behavior. An example of this currently exists in Finland. Currently in Finland, there already exists many laws that prohibit and constrain the advertising of alcohol, and more laws are currently being placed that will become effective January 1, 2015, such as the law that alcohol ads can only appear on television after 10pm. These laws that limit and decrease demand for alcohol are one option governments have to partially take account of the negative externalities of alcohol.


A successful example of a market-based solution is for subsidy. It is likely that the government will initially attempt some form of tax on alcohol to decrease supply, and by doing so increase price and decrease quantity demanded, and partially account for the negative externalities of consumption of alcohol. With the revenue from that tax, the government will have the opportunity to subsidize a good or service with a positive externality such as education. An example of successful subsidy is the government of Singapore currently giving $32 million in subsidies to the Early Intervention Programme for Infants and Children, and this organization focuses much of its resources in educating its kids. However, subsidies from governments can be dangerous. The larger the subsidy, the larger the opportunity cost of the subsidy for the other options available with that money. Also, a government may subsidize a business that ends up exiting the industry, and this would result in a wasted subsidy. This means that subsidies are a dangerous way to attempt to account for the negative externalities of consumption of alcohol.

Taxes, in some aspects, may be effective at controlling alcohol consumption because increase in price dissuades consumers from purchasing huge amounts of alcohol. As it is a market-based solution, it internalizes the externality so that costs are paid for by producers and consumers that are parties to the transaction. However, taxes are oftentimes more ineffective than effective, as seen with the failure of the 7.5% tax on alcohol in the U.K. in February 2014. Increasing the price of alcohol to reduce alcohol consumption may actually backfire, as addicted consumers may still buy alcohol regardless of high price due to the theory of elasticity. Also, there are technical difficulties because it is hard to determine the size of the tax, there is a danger to overtax or undertax, but as it is time consuming, inaccurate, and expensive in the long-run, it distorts the price signaling mechanism. If enforcement costs are too high, there may actually be no money left to reallocate to the negative externality. These high costs also represent an opportunity cost for the government, because research from Ernest and Young found that if U.K. lowers its enforcement costs, it would boost public finances by £230m in 2014 alone and create more than 6,000 jobs. Moreover, there is elasticity issues because of government corruption and thus misuse of tax money. Because it is a market-based solution, externality is not internalized, and there is no market-based incentives so that there is no distinction between firms. Taxes on all producers are also unfair because of the firms’ different levels of alcohol and thus different levels of effect on society. However, these blanket taxes may lead to shut down of firms and thus aggravate unemployment. Furthermore, taxes may aggravate income inequality. For example, in the U.K poorer people are the most affected by the taxes, and thus taxes are regressive.

Another example of failure is for legislation, as enforcing laws may have an adverse effect. For example, currently in many universities and campuses the legislation only had a slight effect on reducing the consumption of alcohol because the schools circumvent alcohol legislation took a long time for the students to be adjusted, be aware about the law and most importantly if the rules are to have campus-wide effect, it required lots of faculty input to track down those students who intake alcohol illegally. Thus, due to these drawbacks the legislation may only be efficacious in the long run.

There are also failures for price floors, another market-based solution. An example is UK’s price floor of alcohol sales for April 2014. Because alcohol is a demerit good as it comes with negative externalities such as binge drinking and drunk driving, the government intervention set a price floor on alcohol. Thus, the price increased and as a result, quantity demanded decreased and quantity supply increased. This creates a surplus because quantity supplied is bigger than quantity demanded. In a free market without government intervention, the market prices will restore equilibrium by decreasing the prices. However, because of government intervention, the market cannot clear at the original equilibrium point, and thus the surplus will persist. The consequences are surplus, government storing the excess carbon, donating it as aid, or paying the producers not to produce. Moreover critics of the price floor in England state that it is laughable because it will affect only 1% of sales. These negative consequences would be made up for in the short-run, as the solutions will ultimately benefit both consumers and producers by decreasing the price and increasing the supply of onions. However, in the long-run, sustainable solutions must be developed.

Attempting only one option such as a solitary tax or law to overcome the failure of the alcohol market to take account of the negative externalities of alcohol will not result in success, but multiple options such as an anti-alcohol education campaign and decreasing of alcohol advertising must be attempted simultaneously to take account of the negative externalities of alcohol in consumption.

Seung-Yeon Kang