The market forces of demand and supply lead to equilibrium price and quantity that can be used to allocate sources effectively in many of the markets. At times they fail to deliver the best level of output for society. The government intervenes using various methods to correct market failure. This report details the six different types of market failure which can occur in the UK in addition to critically detailing how the government attempts to correct market failure. 2. Externalities According to Samuelson (1954) ‘Externalities create a divergence between the private and social costs of production’.
Social costs are the production cost of a product or service including third party costs; in the event of a negative externality the social costs are much greater than private costs i. e. pollution. Externalities are external costs and benefits which arise during economic activity but which are not considered by the buyers and sellers involved as they effect third parties only. Ignoring external costs and benefits can lead to the wrong level of output in the market. Negative externalities, occasionally referred to as external costs, are the costs that separate social and private costs.
They are the costs paid for by third parties, which is usually society as a whole. If negative externalities are left to the market mechanism it could lead to over production. Chivian and Bernstein (2008) concluded, ‘soft drinks in large quantities are unhealthy and could lead to medical problems’. This would increase the medical costs for the government, to tackle this issue they could tax soft drinks to discourage use in addition to elevating such charges from healthy drinks consequently providing a cheaper and healthier alternative. Consumers can create externalities by consuming certain goods or services.
•Pollution from privately owned cars or taxis •Public damage caused by alcohol abuse •Litter on streets The UK government address these negative externalities through two primary functions; legislations and taxations. Pressure from environmentalist along with studies confirming the existence of global warming forced the UK government to introduce ‘Green taxation’. This includes an increase in petrol prices to discourage use of fuel reliant cars, increase in excise duty on alcohol as well as fines for perpetrators caught in the act of littering.
Indirect taxes are used as a means of deterrence on products which could lead to market failure. They differ to specific taxes such as excise duty on tobacco as they are not fixed sum per unit. VAT is an indirect tax which raises cost of production. A pecuniary externality is a type of negative externality which relates to the economic activities rather than physical resources. Apple increased its market share from 25% to 36% in the mobile phone market while others have lost theirs; those suffering losses have incurred a pecuniary externality (Apple iphone market share, 2011).
The key difference between pecuniary and real externality is while real externality ought to require compensation pecuniary should not. Positive externalities, if left to market mechanism, could under produce and would not reach level of output which is socially efficient. •Education system, government provides student finance to encourage higher education •Health service, government provides free health service By investing in human capital via promoting education and providing incentives to stay in education i. e.
EMA, the government is assisting corporations through nurturing more educated individuals. This is essential in sustaining the country’s development. Positive externalities can also have negative effects; UK boasts one of the largest fast food market in the world, Britons spend average of ? 7 million a day on junk food, which contributed to UK being crowned as ‘the fattest country in Europe’ (Britain is Europe’s fattest nation, 2011). 3. Missing markets Missing markets transpires when there is a failure in the market to produce certain goods or offer services in spite of the level of demand.
If conditions are not satisfied markets can struggle to exist and since it is unlikely they will ever form they are called ‘missing markets’. An example of this occurrence is the ‘pure public goods’ which provides to the population non-excludable and non-rival benefits. The free rider problem can be one of the causes which lead to missing markets; the term originates from the example of someone who doesn’t pay fares when using public transport. Everyone would want to use the product but would wait till someone else has paid for it which could lead to under-production or even non-production.
For example, if an individual does not pay tax he can still use the roads or call the emergency services. Pure public goods and other markets with similar characteristics are unlikely to ever be considered as business opportunities by individuals or corporations given the impossibility of charging consumers at the point of consumption. Pure public good includes: street lights, national defence, police, fireworks display etc. All pure public goods have the following characteristics: •Non-rivalry: The consumption of the good by one person does not reduce the quantity available for others.
The amount of usage does not correlate with the availability for example; a lighthouse’s light can be seen by more than one ship at any given time. •Non-excludable: If the good is provided for one anyone can use it, and they cannot be stopped from using it. Once a streetlight is erected it benefits all passers-by and there is no possible way of excluding someone. •Non-rejectable: The public cannot refuse the benefits or consequences of a pure public product. An individual cannot reject being defended by the armed forced of a country, nor can they reject the benefit of street lighting.
To tackle the missing market failure the government may seize control of all operations relating to pure public goods and would then be responsible for meeting the demands of the people. In order to fund projects such as road building the government would raise taxes rather than charge individuals. The government introduces money making schemes such as congestion charges to raise funds for the transport system or charge private airlines landing fees at airports. In 2008, as a bid to attain ? 3 billion, an idea was proposed which would introduce congestion charge in Greater Manchester. 4.
Information asymmetry Information asymmetry occurs when there is a lack of symmetry, or balance, between the knowledge of the buyer compared to that of the seller furthermore, the imbalance gets exploited which leads to a misallocation of resources. For instance, an unscrupulous dentist might tell his patient he needs lots of dental work done, when in reality not so much is required, just to create business. This can also be seen in lawyers, car mechanics, doctors etc. In the UK there are several laws which help the consumers and warrant them rights if a product is purchased or a service is used.
The Trade Descriptions Act 1968 was introduced to prevent manufactures and retailers from misleading consumers by stating all products ‘must be sold as described, of satisfactory quality, and fit for purpose’(OFT, 2011). This prevents businesses from deceiving individuals by allowing them rights to know exactly what the product is. To inform consumers of their rights the government has setup websites and institutions which can be used to attain information readily. The OFT (Office of Fair Trading) was set up in 1973 to ‘enforce both consumer protection and competition law, acting as the UK’s economic regulator’.
They can be contacted by consumers who would be given guidance about their matter and legal advice. The OFT carry out investigations into alleged unfair practices if consumers feel wronged for example, in June 2010 an investigation into credit score websites was opened after consumers complained about being charged monthly subscriptions fees. Verdict was reached and the accused companies agreed to not mislead consumers by making these charges known (Investigation into unfair practices, 2011). 5. Lack of competition in the market
According to O’Connor (2012) a monopoly occurs if at least of the two conditions are satisfied: •The only organization in the industry •Substantial barriers of entry The UK government and many other agencies, informally, refer to any company with more than 25% market share as a monopoly. This includes companies on a national, regional or local scale. Monopolist businesses act as price maker, due to lack of competition, therefore can create artificially high prices if demand exists to earn abnormal profits.
This is very different to the situation which occurs when competition exists in the market where businesses are constantly trying to reduce prices to undercut competitors. A restrictive trade practice is a strategy used to reduce competition and raise prices of products. Cartels are formed when businesses agree to set prices high, they are also illegal in UK. Competitors are forbidden to collude in restricting the flow of goods to a particular person or business. The UK government has various legislations to prevent abuse of power. Monopolies and Restrictive Practices Act (1948)
In 1948 the Monopolies Commission was created to investigate industries where businesses are acting in collusion to limit competition. A report will be published after the investigation is concluded and will be given to the government to take necessary action. Monopolies and Mergers Act (1965) This act was created to investigate or prevent business that control at least 25% of the market from merging together. The Monopolies Commission would investigate the case then allow the merge to take place or disallow it if it does not act in the interest of the public. Restrictive Trade Practices Act (1956)
Restrictive Trade Practices Act made it illegal for manufactures to act in collusion and control the prices at which their product is sold at in retail stores. The Registrar of Restrictive Practices acts as a database, businesses have to register any restrictive agreements between the manufactures. Fair Trading Act (1973) This act established the Office of Fair Trading with the aim of enforcing the act. Consumer protection and Competition law were the main agenda. The goal is to ensure markets work well for consumers, ensure strong competition and prohibit unlawful practices.
Consumer protection was enhanced as businesses would be given warning at first but will be taken to court if problems persist. Competition Acts (1980 and 1998) Large businesses may limit competition and increase profits by predatory pricing, excessive prices, refusal to supply and price discrimination. This act was created to ensure businesses do not abuse their dominant market position and to deal with restrictive business practices. The EU influenced this act as the UK had to comply with EU competition policy.
This act will be enforced by the Director General of Fair Trading and business if found at fault will be liable to financial penalties. Enterprise Act (2002) This act establishes new competition authorities, reformulates the law regarding mergers and markets, changed the law governing insolvency bankruptcy and criminalises anti-competitive behaviour. It also enhanced the Office of Fair Trading powers allowing it to carry out searches under warrant on the suspected mergers. Businesses can now appeal against the decisions made by the Competition Commission.
The Minister of Trade and Industry used to play a major role but due to inconsistencies he no longer has the final say regarding mergers. 6. Unstable prices Unstable prices apply particularly to commodities, any naturally accruing substances, such as fossil fuels, coffee, wheat etc. If left to the market mechanism they tend to suffer from fluctuations in prices much more frequently than manufactured goods, which create problems for the suppliers of these commodities as they cannot plan with any certainty on what revenue they are going to receive.
Lipsey and Harbury (1993) discussed the two strategies the government tries to control the price with: Price ceiling The government imposes a maximum price limit that can be charged for a particular item in order to protect consumers from environments that would make commodities inaccessible. A binding price ceiling is when the government decides to set the price ceiling below that of the free market price for example, if bread costs ? 2. 00 on the free market a price ceiling of ? 1. 00 would be considered a binding price ceiling.
However, this can also have undesired results as some suppliers may slump out of the market as they cannot deal with the deficit, causing supplies to reduce and demand to increase as consumers bulk buy cheap items. A non-binding price ceiling is when the price ceiling is set above the free market price giving the suppliers/manufactures a buffer zone which is unlikely to have any practical effect. Price floor A price floor is the minimum price that can be charged for a product or service.
If the mandatory price is set below the free market equilibrium price then it will have no practical effect but if the minimum price is set higher than the free market price it would mean consumers will have to pay more for the product. This could lead to demand falling which would result in manufactures seeing revenue decrease. An example of a minimum floor price is the National Minimum Wage Act 1998 which dictates the lowest amount employees can be paid. 7. Labour market failure
Labour market should, according to Gregg and Wadsworth (2011), reach a certain equilibrium wage and quantity but in practice this rarely happens. Listed below are some potential causes of market failure: •Labour and skills immobility: Labour cannot always be where the jobs are, this is called geographical immobility. Skills immobility is when labour does not possess the right skills to fulfil the job. For example, coal miners lost their jobs when new industries were formed and because of the mismatch in skill they are left unemployed.
•Discrimination: Race, gender, height, weight and age are some examples of discrimination which can take place and could lead to market failure. The government intervenes by creating legislations such as the National Minimum Wage Act and Equal Pay Act to help protect people’s rights at work. They also offer incentives for students to continue into further education. Gangmasters are the main employers in a town and will use their buying power to force wages below the national minimum wage rate.
The government set up the GLA (Gangmasters Licensing Authority) to help control this problem and protect workers (Labour markets, 2009). 8. Conclusion The UK government acts admirable in the event of market failure to prevent further damage being inflicted onto the economy. However, the monopolistic business control acts are not in my estimation deterring businesses from unhealthy practices enough. The green initiative is laughable at best considering most households generally are in possession of two cars compared to just a single vehicle few years ago.
Clearly more needs to be done to protect the environment. Although high petrol prices and an increase in insurance act as a deterrent to some the lack of alternatives is detrimental to the efforts. A higher tax should be implemented on tobacco as it is causes negative externalities which not only affect the individual but also the government, NHS spend on average five billion a year on treating diseases directly caused by smoking (Buckley,2003). 9. Bibliography Samuelson, P. A. , 1954, the pure theory of public expenditure, harvard university press. Chivian,E. C. and Bernstein, A.
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