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Submitted by Jishnu on

Thanks for your comments, Luis. I think that some market failures fall in the category you are talking about: If parents want to keep their children at home and cannot sign long-term contracts, then they may under-invest in education. Subsidizing them will lead to greater education provision; alternatively, you could do the same thing by providing social security that is funded by the next generation (so that the government writes the long-term contract) for retirees. But there is another class of market failures as well, which lead to too little trade. Credit market failures are a classic example. The lender is willing to lend at interest rate r and the borrower is willing to borrow at that rate too. So, they should "trade". But they don't because the lenders don't know the riskiness of the borrower, and everyone willing to borrow at interest rate r with bankruptcy protection is "too risky" for the lender to lend to. In this case, public policy can play a big role, for instance, by building up central databases of credit worthiness. These are information failures due to asymmetric information. So, there is a wide range of policy that can address market failures; the key is to tailor the policy to the market failure that has been demonstrated.