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Market failure is said to occur when goods or services are not allocated in an efficient manner, or when the quantity of a good or service in demand is unequal to the quantity supplied (“Market Failure,” 2007). In other words, market failure is the absence of perfect competition in which prices are known to automatically move to economic equilibrium and the quantity demanded equals the quantity supplied (“Perfect Competition,” 2007). Thus, market failure usually calls for public ownership or regulation to move the market toward efficiency (“Market Failure,” 2006).
Still, the best solution to best market failure remains pure or perfect competition. The imperfect market is a market failure in which some of the producers and/or consumers are dominant enough to influence the price and quantity of the good or service by their actions alone (“Imperfect Market,” 2007). The oligopoly, the monopsony, the cartel, monopolistic competition, the oligopsony, price skimming and price discrimination are all examples of imperfect markets or market failures because they allow for mechanisms other than the supply and demand to control prices (“Market Failure,” 2007).
A monopoly is a rather expensive type of market failure, seeing that it often results in antitrust lawsuits. Regulators are rather concerned about the effects of a monopoly, which is the reason why the European Union antitrust chief continues “pressing for open markets” as certain European countries establish energy giants (“Competition Test,” 2007). The EU anti-trust chief would like the European energy sectors to be open to foreign competition (“Competition Test”).
On the same note, the United States Justice Department had presented an antitrust case against Microsoft with the argument that the company had used its near monopoly position in the operating system market in order to gain an unfair advantage in the browser market (“Microsoft”). In a perfectly competitive market there are many firms supplying a product or service. A monopoly, on the contrary, is the only firm in a particular market. The market price in the industry is determined by the supply and demand for the product or service in question.
As the market supply decreases, the price of the product increases (“Microsoft”). A monopoly is in a very good position to decrease supply and thereby increase the price that it charges for the product or service that it supplies. Since it has no competitors, there is no compulsion to decrease the price in order to beat competition. All the same, the monopolist faces a loss because now there are fewer buyers for its products or services, given that the price has increased. So as to offset the decrease in profits, the monopolist would decide on a price that is higher than its marginal cost.
If the marginal cost is represented by the supply curve, the monopolist would decide to produce a quantity that is less than the quantity at the intersection of the demand and supply curves, that is, the quantity produced in a state of perfect competition (“Microsoft”). According to economists, the Dead Weight Loss of a monopoly must be borne by the entire economy seeing as the monopoly is charging a price that is higher than the price at the intersection of the demand and supply curves in a state of perfect competition, and also producing a quantity that is lower than the quantity produced in a state of perfect competition.
The monopolist may decide to continue increasing the price by reducing the quantity that it supplies, and thereby increase the Dead Weight Loss to society (“Microsoft”). This is exactly why the U. S. Justice Department or the EU anti-trust chief must intervene to put an end to monopolistic practices or market failure in favor of pure or perfect competition. There are other characteristics of the perfectly competitive market that tend to oppose market failure when combined.
Homogeneity of goods or services, complete and perfect information, equal availability of technologies for the producers, mobility of resources, free entry, and the individual actions of producers and buyers (as opposed to group behavior) are some of the defining characteristics. Moreover, in a perfectly competitive market, the consumers’ goal is to “maximize utility,” while the maximization of profits is the goal of producers (“Perfect Competition”).
These factors, in combination, may lead to productive efficiency in addition to allocative or Pareto efficiency. Productive efficiency is attained by producing a good or service at minimum cost so as to maintain a price that is reasonable for both the producer and the consumer. Pareto efficiency, on the other hand, refers to the condition where price is equal to the marginal cost of producing a good or service, and the producer is unable to make a profit (“Perfect Competition;” “The Market Economy”).
A firm that operates in a perfectly competitive market may choose to allow consumers to benefit from the allocative efficiency of the perfectly competitive system for a while. But, it is not expected to produce public goods, seeing that these goods are not considered profitable to produce in either the short- or the long-run. The benefits of public goods or services cannot easily be restricted to those who pay for them. An excellent example of a public service is national defense that all people in the nation may enjoy.
The benefit that an individual gains from national defense is not reduced by the benefits that are available to others. Furthermore, there is no way of excluding people from the benefits of a public good or service once it has come into existence. This creates the free-rider problem. Because the private firm in a perfectly competitive market sells for profit, it is not feasible for it to produce a public good or service that individuals other than direct consumers would also be able to enjoy without payment.
Hence, the production of public goods or service, which usually happens to be the responsibility of the government, is a market failure that opposes perfect competition (“Market Failure,” 2007). Other sources of market failure include transaction costs as well as failures facing the organization. If a private firm in a perfectly competitive market must face significant litigation, regulation, contract or decision-making costs, for example, it may not be able to sell its products or services at prices that allow for allocative or productive efficiency.
Similarly, if a firm is slow at organizational learning or enforces rules that are not truly conducive to the maximization of profits, organizational failures would translate into market failure (“Market Failure,” 2007). Externalities, too, are a market failure or threat to the perfectly competitive market. Defined as spill-over or third-party effects, externalities arise from the consumption and/or production of goods or services for which nobody pays.
If a private firm in a perfectly competitive market were to produce a public good or service, there would be a positive externality where the marginal social cost (that is, the cost paid by all who enjoy the public good or service) is less than the private marginal cost, which is the cost of production faced by the firm. On the other hand, if a chemical plant pollutes the environment, a negative externality would result with the marginal social cost or the cost paid by society exceeding the private marginal cost (“What are Externalities”).
Seeing that perfect competition is meant to maximize the benefits of society as well as producers, externalities are considered a form of market failure. As mentioned previously, perfectly competitive markets are also reliant on perfect information, that is, all of the agents are perfectly informed about the availability of the products or services, in addition to prices that are charged by the suppliers. So, consumers find it easy to make purchasing decisions with free and complete information about products and services that they are interested in paying for.
Market failure occurs when the information available to suppliers and consumers is imperfect. There may be misunderstandings or uncertainty about the actual benefits or costs of a product or service; or there may be complex, misleading or inaccurate information that disrupts the process of buying and selling in a purely competitive system (“Imperfect Information”). Regardless of the nature of imperfect information, or whether externalities are positive or negative, market failure results when the perfectly competitive market is unable to operate at levels of efficiency that allow all agents to benefit.
Public goods, transaction costs, failures of the organization, and imperfect markets are additional examples of market failure. The government typically assumes responsibility for correcting these failures. The best method available to the government for the correction of a market failure is the establishment of a perfectly competitive market. References Competition Test. (2007, Sep. 5). The Wall Street Journal Online. Imperfect Information. Tutor2u. Retrieved May 4, 2008, from http://www. tutor2u.
net/economics/revision-notes/as-marketfailure-imperfect- information. html. Imperfect Market. (2007). Answers. Retrieved May 4, 2008, from http://www. answers. com/topic/imperfect-market? cat=biz-fin. Market Failure. (2006). OECD. Retrieved May 4, 2008, from http://stats. oecd. org/glossary/detail. asp? ID=3254. Market Failure. (2007). Answers. Retrieved May 4, 2008, from http://www. answers. com/topic/market-failure? cat=biz-fin. Microsoft: Is The Company Too Big? Retrieved May 4, 2008, from http://www. humboldt. edu/~ee3/econ104/topics/monopoly.