Question

In Brazil, the government is also concerned about the situation explained in question 1. But it has come to light that many coffee brands are wrongly marketed as fair trade by unscrupulous coffee companies, disguising the low wages paid to bean pickers. Such firms also contribute to groundwater pollution and deforestation by squeezing coffee farmers who need to cut production cost to make a living. Use the theories of market failure and government intervention to explain the reasons for this concern. Identify different suitable government interventions that the Brazilian government may consider. Critically discuss potential problems with these interventions.

Answer 1

The above case of coffee farmers depict an example of negative externality where pollution caused by the firms and exploitation of the coffee farmers lead to marginal damage for the society and thus marginal social cost of coffee production is more than marginal private cost of coffee production. Due to the problem of negative externality, there is over production in the economy as compared to socially efficient level of coffee production because marginal damage to the society is not taken into consideration. In order to correct this externality, government intervention in the form of taxes needs to be imposed on the firm so that socially efficient level of output is equal to market efficient level of quantity. This can be depicted in the diagram as: