Saturday, December 31, 2011


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In practice, there are many problem and markets sometimes fail to meet our needs. Market failure arises in a number of ways. We use the term Market Failure to cover all the circumstances in which equilibrium in free unregulated markets (i.e. markets not subject to direct price or quantity regulation by the government) will fail to achieve an efficient allocation (Begg, Fischer, Dornbusch, 000, pg65). In economics terms freedom of enterprise will tend to produce inequality of wealth, because some people will be more talented, innovative, work harder, etc, than others. They will make profits where others fail. This means that individuals purchasing power, and hence the share of resources, which they can command, will be unequal. Therefore, we must be alert to ¡®market failures¡¯ in situations in which marketers attempts to solve problem may make them worse or cause other problems. Below are the possible sources of distortions that lead to market failure.

Imperfect Competition

One serious deviation from perfect competition comes from imperfect competition or monopoly elements. Recall how strict is the economist¡¯s definition of a ¡°perfect competitor.¡± The mere presence of a few rivals is not enough for perfect competition. Rather, perfect competition in a market arises when there is a sufficient number of firms or degree of rivalry such that no one firm can affect the price of that good. An imperfect competitor is one whose actions can affect a good¡¯s price (Varian, 1, pg 10). In reality, then almost all business owners, except possibly the millions of farmers who individually produce a negligible fraction of the total crop, are imperfect competitors. At the extreme of imperfect competition is the monopolist- a single supplier who determines the prices of a particular good by himself (Begg, Fischer, Dornbusch, 000, pg55). It is also perfect competition that leads firms to set marginal cost equal to price and thus to marginal consumer benefit. Under imperfect competition, producers set marginal cost equal to marginal revenue, which is less than the price at which the unit had sold. Since consumers equate price to marginal benefits derived from the last unit, in general marginal benefit will exceed marginal cost in imperfectly competitive industries. Such industries will tend to produce too little. Expanding output would add more to consumer benefit than it would to production costs or the opportunity cost of the resources used (Begg, Fischer, Dornbusch, 000, pg65).


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A second way is which an unregulated market mechanism may lead to an inefficient outcome arises when there are spillovers or externalities. An externality arises whenever an individual¡¯s production or consumption decision directly affects the production or consumption of others other than through market prices (Ali, 1,pg8). Externalities are things like pollution, noise, and congestion. What they have in common is that one person¡¯s actions have direct costs or benefits for others people, which that individual does not take into, account. Much of the remainder is devoted to analyzing this distortion. The problem arises because there is neither a market nor a market price to ensure that the marginal cost of that noise to other people (Begg, Fischer, Dornbusch, 000,pg65). Suppose a chemical firm discharges waste into a lake, pollution the water and directly imposing an additional production cost on anglers (fewer and smaller fish, which are harder to catch) or a consumption cost on swimmers (less pleasant swimming and a dirty beach). If there is none ¡®market¡¯ for pollution, the firm can pollute the lake without cost. Its self ¨Cinterest will lead it to pollute until the marginal benefit of polluting (a cheaper production process for chemicals) equals its own marginal cost of polluting, which is zero. It takes no account of the marginal cost its pollution composes on angels and swimmers (Begg, Fischer, Dornbusch, 000, pg66). In this case, there is a divergence between the individual¡¯s comparison of marginal costs and benefits and society¡¯s comparison of marginal costs and benefits. Free markets cannot induce people to take account of these indirect effects on other people if there is no market in these indirect effects.

The things that Externalities can done

Markets work well when the price of good equals society¡¯s cost of producing that good and when the value of the good to the buyer is equal to the benefit of the good to society. However, the costs and benefits are sometimes not fully reflected in market prices. Consider the problem of pollution. A firm produces chemicals and discharges the waste in to a lake. The discharges pollute the local water supply, kill fish and birds, and create an offensive smell. These adverse side effects represent costs to society of producing the chemical, and should accordingly be reflected in its market price, but they may not be. Unless the chemical company is charged for the damages caused by its pollution, the market price of its output will understate the true cost of production to society. There is an externality in the production of the chemical (Begg, Fischer, Dornbursch, 000, pg66). Externalities are not all negative. The homeowner who repaints her house provides spillover benefits for the neighbors; they no longer have to look at a dilapidated house. In all externalities, there exists something that affects firms¡¯ cost or consumers¡¯ welfare (such as pollution or views of newly painted houses) but is not traded in a market. Economists often say that ¡®missing markets¡¯ causes externalities.

When externalities are present, market prices do not reflect all the social costs and benefits of the production of a good. Government intervention may improve the functioning of the company, for example by requiring firms to treat their waste products in certain ways before dumping them. Since externalities involve missing markets, they can also be handled in principle by market-type solutions. The government might charge firms (an estimate of) the damages their pollution cases, or might permit a certain amount of total pollution and allow firms to buy and sell rights to pollute. Externalities can provide the justification for a number of government activities besides pollution control (Begg, Fischer, Dornbusch, 000, pg48). Examples range from control of broadcasting (interference is an externality) to various restrictions on land use.

Public goods

It is possible to prevent firms from dumping wastes by imposing regulations; it is much more difficult for government to encourage the production of public goods. These are the economic activities with conveying large or small benefits to the community that cannot efficiently be left to private enterprise. Important examples of production of public goods are the maintenance of national defense and of internal law and order, the building of a highway network, and the support of pure science and public health. Private provision of these public goods will not occur because the benefits of the goods are so widely dispersed across the population that no single firm or consumer has an economic incentive to provide them. Therefore, private provision of public goods will generally be insufficient; government must step in to provide public goods. In buying public goods like national defense or lighthouses, government is behaving exactly like any other large spender. By casting sufficient dollar votes in certain directions, it causes resources to flow there. The price system then takes over and ensures that the government-purchased lighthouses or fighter aircraft are produced (Begg, Fischer, Dornbusch,000, pg66).


Government must find the revenues to pay for its public goods and for income-redistribution programs. Such revenues come from taxes levied on incomes, wages, consumer sales, and similar items. Moreover, taxes are raised a t all levels of government likes city, state, and federal. Taxes differ from other uses of our incomes in one important respect everyone is subject to the tax laws; we are all forced to contribute our share of payments to the government. It is true that the citizenry as a whole imposes that tax burden on itself, and surely, we would agree that each citizen has the right to his or her share of the public goods produced by government. However, the close connection between spending and consumption that we see for private goods does not hold for taxes and public goods (Harvey, 1,pg6). Eric buy a hamburger or a wool sweater only if Eric want one, but Eric must pay my share of the taxes used to finance defense, space research, and public education even if Eric don¡¯t care a bit for these activities.


1. Begg, Fischer, Dornbusch, 000, Economics, 6th edn, The McGraw-HILL Publications, United Kingdom.

. Ali. H., 1, Comprehensive Economics Guide, nd edn, Oxford University Publications, Singapore.

. Harvey .J, 1, Modern Economics, 6th edu, The MACMILLAN Publications, Great Britain.

4. Tucker Irvin.B, 001, Economics for today, rd edu, South-Western Thomson Publications, United States of America.

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