Question

Explain why government attempts to solve market failures can lead to additional inefficiencies because of “rent-seeking” activities.

Short answer

The government policies against different problems that lead to market power, benefit a group of entities at the expense of other entities. The worse-off entities from the respective government policy might try to oppose such by spending a considerable amount causing rent-seeking activities.

Step-by-step solution

Rent-Seeking

The term refers to those activities where the party opposing the government policies in terms of their interests pays a lumpsum amount to abort the policy from enactment; this is called rent-seeking activity.

Suppose a politician has a lot of power and thus orders to regulate a monopoly in the market. Regulating infers the activity where the monopoly sells its goods at a perfectly competitive price.

The graph above shows that if the politician successfully enacts the regulation, the monopolist will lose a profit, as denoted by triangle $A$.So, to stop the enactment, the monopolist will be willing to spend up to amount $A$which is rent-seeking for its profitable purposes. On the other hand, the consumers who were to receive a surplus of $A+B$would be willing to pay the amount $A+B$to enact the regulation as they receive public benefits. Since this policy is a public good, the consumers are likely paying less compared to the monopolist to whom the private policy had to spend more. Thus, due to such circumstances, the monopolist usually does not involve in rent-seeking purposes.

Thus, one can understand that such government policies can cause problems of rent-seeking, which further brings inefficiency to the market.