Market Failure

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Transcript of Market Failure


MARKET A market is any one of a variety of different systems, institutions, procedures, Social relations and infrastructures whereby businesses sell their goods, services and labour to people in exchange for money.

DIFFERENT TYPES OF MARKET Perfectly Competitive Market-- Goods/services offered are all same; Numerous buyers and sellers and no single buyer or seller can influence the market price - price takers Oligopoly--Few sellers; Each participant is aware of the actions of the others Monopolistic --Goods/services are slightly differentiated; Numerous sellers each seller has some ability to influence the price Monopoly-- No substitute available for the goods/services offered

MARKET FAILURE A market failure occurs when the market does not allocate scarce resources to generate maximum social welfare. A wedge, so as to speak, exists between what a private person does given market prices and what society wants him or her to do to protect the environment. Such a wedge implies wastefulness or economic inefficiency, resources can be reallocated to make at least one person better off without making anyone else worse off.

Brief History of Market Failure Preclassical economics primarily government regulation; nineteenth century classical economics harmonization of self interest and social interest; neoclassical economics presence of market failures and government to act as an efficient coordinating force John Stuart Mill, Henry Sedgwick mark a turning point in the literature of market failure

The concept of market failure initially appeared as a means of explaining in economic terms why the need for government expenditures should arise normative judgement about the role of government As it matured the market failure concept on an additional characteristics diagnostic tool by which policy makers learned how to objectively determine the exact scope and type of intervention

Definition of Market Failure Market failure when the competitive outcome of markets is not efficient from the point of view of the economy as a whole This is usually because the benefits that the market confers on individuals or firms carrying out a particular activity diverge from the benefits as a whole a case in which a market fails to efficiently provide or allocate goods and services in comparison to some ideal standard, such as the perfect competition model

REASONS FOR MARKET FAILURE Market failure occur due to several reasons 1. Environment as a public good Certain parts of the environment such as communal land in Zambia could be considered a public good and as such have a characteristic of non excludability. Commonly owned land where there are no established property rights produces little incentive to care for the environment.

Slash and burn agriculture or chitemene can lead to deforestation, as cutting down trees incurs no cost given that the farmers are shifting to new areas. However the environment does not conform to the other characteristic of public goods that of being non-rivalrous. Using the land for farming means that the land can not be used for conserving wildlife. The environment is scarce and if the use of environment is free then it will invariable be over-used.

The existence of externalities The production of agricultural goods, horn, ivory, electricity and tourism all involve incurring private costs and yield private benefits. Typically the market price of a good or service reflects these private costs and benefits. The production and consumption of goods and services can involve additional external costs or negative externalities experienced by people other than those who are directly producing or consuming the good.

Negative Externalities Negative externalities lead markets to produce a larger quantity than socially desirable.

Positive externalities lead markets to produce a smaller quantity than is socially desirable

For instance the relocation of people when the Kariba Dam was built or the diversion of water supplies for the benefit of the tourist industry. These spill over effects can also impact on the natural history such as the extinction of species of wildlife. The socially efficient level of output and price would be at a level where these external costs were taken into account. This would result in a higher price and a lower output.

3. Ignorance Given the limited access to education there is considerable lack of knowledge about the impact of poaching and hunting on the population of many species of animals. Markets fail where the lack of information means that rational decisions are not made. If the communities were educated about the impact of their actions on the level of sustainability then different decisions might be taken.

4. Short term benefit versus long term benefits Killing a rhino and selling its horn will generate considerable income and give significant benefit to the family of the hunter. However the impact of killing the rhino on future generations is not considered. Self-interest, one of the guiding principles of the free market fails to take into account of the future interests of others. Little if any consideration is given to the future.

Market Failure due to Market Power Monopoly A price maker compared to price taker of a firm in competitive market A firm is monopoly because of --It owns a key resource; The government provide a single firm an exclusive right to produce some good or service eg. patents and copyrights given by the government Provide incentive for research and creativity activity offset by the monopoly prices Natural Monopoly - The costs of production make a single producer more efficient than a larger number of producers

Market Failure due to Market Power Monopoly In a competitive firm price equals marginal cost while in the case of monopolized market price exceeds marginal cost Monopolist charges a higher price therefore earning a higher profit Also there is a deadweight loss implying that the monopolist produces less than the socially efficient quantity of output.

Market Failure due to Market Power Monopoly In a competitive firm price equals marginal cost while in the case of monopolized market price exceeds marginal cost Monopolist charges a higher price therefore earning a higher profit Also there is a deadweight loss implying that the monopolist produces less than the socially efficient quantity of output.

Market Failure due to Market Power Monopoly

Market Failure due to Oligopoly In reality a firm is neither perfectly competitive or monopoly in nature rather somewhere between. Oligopoly is a market with only a few sellers: A key feature of oligopoly is the tension between co-operation and self-interest. The group of oligopolists is best off co-operating and acting like a monopolist producing small quantity of output and charging a price above marginal cost cartel or collusion However the self interest is hindrance to cooperate (example of two prisoners) dominant strategy leading to Nash equilibrium which is less than what monopolist would make profit

Market Failure due to Information Asymmetry - (Principal Agent problem) Buyers and Sellers will have different information about the product s attributes In one instance when the consumer is less informed there will be a producer surplus but also a net loss to society Adverse Selection, Moral hazards are a result of information asymmetry


CLIMATE AND MARKET FAILURE Greenhouse gas emissions are a by-product of many human activities, and in most cases they are unrecognised emissions into a global atmosphere that nobody owns. For example, driving cars and burning of fossil fuels to produce electricity in every country, adds to the global stock of greenhouse gases, but the by-product is not included in the transaction costs or prices.

In time, the build-up of the global stock of greenhouse gases leads to climate change and external costs in the form of changes in agricultural productivity, severe climatic events with adverse effects on infrastructure, loss of biodiversity and so forth. The production of greenhouse gases and associated climate change has sometimes been labelled the mother of all externalities .

If left to market forces, ignoring the external costs of greenhouse gases will result in too much production and consumption of products intensive in the use of greenhouse gas, as well as in the choice of production methods that produce too much greenhouse gas.


EXAMPLES McDonald's: For years, London Greenpeace distributed a brochure criticizing McDonald's role in rainforest destruction, labor exploitation, animal abuses, unhealthy food and child manipulation. McDonald's first infiltrated the group with spies, then attempted to censor the protesters by suing them in court for libel. The case became the longest in British libel history when the defendents put up a surprisingly strong defense. The case received international attention and became a major public relations disaster for McDonald's when their own witnesses actually confirmed the brochure's criticisms. (See

Global Warming Fossil fuel Industry.

Asbestos-based building materials now recognized as a carcinogenic Insulation, floor tile and popcorn ceiling materials produced by a number of manufacturers.

Government Intervention to Correct Market Failure The economic rationale for Government intervention(i) Correction for market failure/loss of economic efficiency (ii) Desire for greater degree of equity in the distribution of income and wealth

Several forms of government intervention are possible to correct for perceived market failure

Government Intervention t