Which of the following is a potential reason government intervention may fail to improve welfare due to externalities?

• A. Information gaps and administrative costs.
• B. Political incentives and regulatory capture.
• C. Incorrect policy design.
• D. All of the above.

Answer: (D)

Interventions to correct externalities can fail when the policy environment is imperfect in several ways. If policymakers don’t know the exact size of the externality or the precise social costs and benefits, the corrective measure may misprice the externality, yielding too little or too much intervention. At the same time, administrative costs and information gathering efforts reduce the net welfare gain from the policy, so even a well-designed idea can be diluted in practice. Political incentives and regulatory capture mean rules may be shaped to benefit certain groups rather than improve overall welfare, leading to under- or over-correction or enforcement problems. And even with good information and honest motives, incorrect policy design—wrong target, wrong magnitude, leakage, or enforcement difficulties—can cause the intervention to misfire. Put together, these factors show why government action can fail to improve welfare, so all of these reasons are possible causes.