Assess the usefulness of behavioural economic theory compared to traditional economic
policies in helping governments to correct market failure.
Market failure occurs when the free-market mechanism causes a misallocation of resources in the
economy, either by entirely failing to offer a good or service or by providing the incorrect quantity.
Behavioural economic theory is improving economic welfare by designing the decision-making
environment in a way to influence the decision, which is taken. On the other hand, Traditional
economic policies, such as government involvement, aim to address such market failures by
assuming that people would always make rational decisions. In this essay, I will discuss whether
behavioural economic theory or traditional economic theory is more useful in helping governments to
correct market failure.
Behavioural economic theory is useful because it helps the government to correct market failure
because choice architecture and framing encourage customers to adjust their spending habits in a
way that enhances allocative efficiency and boosts economic welfare. This means behavioural
economic theory is beneficial in assisting governments in correcting market failures. Governments can
apply nudges to influence people's behaviour in a predictable way without restricting their options or
affecting their economic incentives. A government, for example, can urge individuals to quit smoking
by only permitting it in particular locations. This would reduce demand and hence overproduction of
an item like tobacco; effectively correcting market failure. This is good for society because, unlike
traditional economic programmes, which often aim to force individuals to change their behaviour,
nudges simply steer them in the right direction without being too restrictive. Behavioural economic
theory, in this sense, as well as through subtly implemented mandatory choice and restricted choice
schemes, is a less restrictive and a more approved type of market failure repair as opposed to
harsher traditional policies, such as fines and legislation prohibiting activities. However, because
behavioural economics is a relatively new concept, and because most studies are done in a
laboratory, which fails to properly imitate real-world situations, there are limitations to the accuracy
and trustworthiness of the data.
However, traditional economic policies are useful in helping the government to correct market failure
through government intervention. For example, implementing a tax on a harmful good like cigarettes
can assist to reduce its excessive consumption. Traditional economic policy removes negative
externalities in this sense. To compensate for perceived market failures, some economists and
policymakers advocate plenty of interventions and restrictions. Tariffs, subsidies, redistributive or
punitive taxation, trade restrictions, price floors and ceilings, and lots of other market distortions have
all been justified as a means of rectifying inefficient outcomes. However, such taxes are frequently put
on price inelastic goods, such as tobacco. Despite the subsequent increase in fiscal dividend,
consumption will only be reduced by a small amount due to customers' becoming dependent and
addicted to smoking. In addition, if the tax is too extortionate, it may encourage and lead to smuggling
and black-market activities. This problem can be solved by behavioural economic theory since this is
a great example of bounded self-control.
Another reason that behavioural economic theory is useful in helping the government to correct
market failure is because behavioural economics is vital in determining the causes of market failure,
whether due to bounded self-control, cognitive biases, altruism or asymmetric information. Due to this,
it is very useful in predicting future decision-making processes and patterns, as well as giving useful
tools for subtle influencing and economic manipulation through choice architecture, nudge theory and
framing. Given the flaws and unrealistic assumptions underlying traditional economic strategies,
behavioural economic theory is beneficial in assisting governments in correcting market failures
However, there is no assurance that the nudge policy will be successful, and the outcomes will be
very unpredictable. This is because consumers would still have the option to ignore the policy and
