What Is Meant by Market Failure

Custom Student Mr. Teacher ENG 1001-04 12 September 2016

What Is Meant by Market Failure

Why do some markets fail? Market failure is said to occur when the price mechanism is unable to allocate resources efficiently. Meaning that the forces of supply and demand lead to a net welfare loss in society, that the resources were not used to their maximum capacity. When there is market failure it is down to the government to correct them. Here are five way in which the market can fail • Externalities

• Asymmetric information • Monopoly market • Public Goods • Factor immobility


“The social optimum output or level of consumption diverges from the private optimum.” (tutor2u,n/a,n/a)

Externalities are external cost and external benefits which occur due to economic activity. However externalities do not involve the buyer or the seller in the purchase of a good or service, as they are only concerned about their private wants. But the effects are felt by the third party, these can be split into two sections. Positive and negative externalities.

Positive externalities:

This is when all the benefits of a good or service are not appreciate. Education is one example of a positive externality, when one person is educated they then have the knowledge to educate others, creating a positive knock on effect. However these benefits are not realised by society and therefore they are under produced.

Negative externalities:

This is when producers or consumer cannot be charged with all the cost. For example air pollution. The producer emits gases fumes from the factory, which cause acid rain and harm to the environment. Consumers smoke cigarettes affecting other people healthy. These are external cost which affect the third party. However they are in high demand and producers manufacture more of the good than is socially beneficial.

However the government attempts to correct this by one, giving subsidies to goods that yield external benefits. This is a grant provided by the government, to increase the level of production in certain industries, in this case it would be education, higher education, farming, and health care, in order to stop the industry from collapsing or to help make society more aware of the good or service. The second attempt for the government is tradable pollution permits. This is when the government cap the amount to pollution emitted by companies, however firms can buy other firms permits to increase their limit.

Asymmetric information

This is a situation where by a consumer or a seller has more information on the product than the other, where by there is imperfect knowledge in the market and therefore a miss allocation of resources. A perfect example is the selling of a car. The owner has full knowledge of the car, about the history, if it’s unreliable, where the seller uses their superior knowledge over the customer. The consumer on the other hand is completely in the dark, and doesn’t know much about the car. Vice versa if the consumer was buying an antique and the seller didn’t know. The consumer can then exploit their asymmetric information and buy it cheap. However it is most common for experts such a doctors, dentists and mechanics to exploit asymmetric information.

Governments attempt to correct this by enforcing laws where by the firm or an individual cannot exploit their position and them must show documentation on why the procedure needs to be done.

Monopoly market

“A monopoly is simply a market with only one seller and no close substitutes for that seller’s product. Technically, the term “monopoly” is supposed to refer to the market itself, but it’s become common for the single seller in the market to also be referred to as a monopoly (rather than as having a monopoly on a market). It’s also fairly common for the single seller in a market to be referred to as a monopolist.”( Jodi Beggs, n/a, page 1) [pic]

(diagram of a monopoly market, with the green area being super normal profit ) The reason monopolies cause marker failure is due to a number of reasons. The first reason being higher prices. Since the firm is uncontested they can set higher prices, this cause the consumer to pay more for the product than it is actually worth, therefore leading to a misallocation of resources within the market. Secondly monopolistic firms are allocativly inefficient, whereby their price is higher than marginal cost, as opposed to a competitive market whereby price would be equal to marginal cost.

This causes there to be a dead weight welfare loss in society, leading to market failure. Another point which causes market failure is productive inefficiency. This is when the company does not produce at the lowest point of the average cost curve leading to an over and unnecessary usage of resources. The last point is paying lower prices to suppliers. The firm can exploit its monopolistic market power by under paying its suppliers for the materials; this once again means there is a miss allocation of resources.

Government attempt to rebalance the market by stopping the firm from enlarging, they do this by no letting them merge with other companies, as well they also enforce RPI- X capping on the company to stop an increase in there product prices.

Public goods

Public goods can be characterise into two different section, Non – rivalry and non excludability

Non-rivalry – these are goods which when consumed by an individual, do not reduce the amount available to others whom may want to consume it. One example of this would be street lighting as you can use the light to see, but it doesn’t mean your taking someone else opportunity to use it .

Non-excludability – this is when a firm cant offer a product or service without others benefiting from the end result. An example of this would be a dam, which stops a town from flooding, therefore all the residents benefit from the dam.

However by providing a public goods there is the free rider problem. This is when an individual consumes for free or pays less for the resources. The best way to describe it would be if national defence was privatised. Then individuals would have to pay to have protection. Say if one neighbour paid for defences and the others didn’t, the whole street would benefit from the protection of that one neighbour, this is the free rider problem. However what would happen in reality, is everyone would think someone else will buy and in the end the service isn’t even bought. Therefore there will be social inefficiency which causes market failure

The way in which the government corrects this is by providing the service through the public sector. To do this they enforce a tax in which everyone pays a small amount for defences. This minimises the chance for the free rider problem to occur and corrects the market failure.

Factor immobility

Another cause of market failure is due the free market failing to provide a sufficient amount of labour ( a factor of production ) to where it is needed. There are two main faults to why this occurs. One being geographical immobility and the second being occupational immobility.

Geographical Immobility: “Geographical immobility refers to barriers people moving from one area to another to find work.” (Geoff Riley , Sunday 23 September, 2012,page2) Here are some barriers, which prevent the mobility of labour • The actual cost of moving and all the effort involved, off puts people from actually wanting to move to a different location • The difficulty of finding accommodation. If an individual is on a basic salary moving to the city will be a lot more expensive to rent or buy a property, therefore the worker searches for local jobs • Personal reasons, an individual may have family near by or even a family of their own. All these factors make it difficult for mobility of labour and consequently the resources are not used to maximum efficiency and causes marker failure

Occupational immobility: “Occupational immobility occurs when there are barriers to the mobility of factors of production between different sectors of the economy which leads to these factors remaining unemployed, or being used in ways that are not efficient.” (Geoff Riley , Sunday 23 September, 2012,page 1 ) Some occupation are mobile, for example computer mechanics, they can move from job to job and can be used in many different industries from shops and offices to monitoring games. However on the other hand steel workers who where made redundant in Wales are not so diverse, their specific skills limit their job opportunities and leads to unemployment. So when the mines close, many workers could not relocate and this lead to a waste of resources not being used. So the knock on effect is market failure.

Ways in which the government are trying to increase the mobility of labour for each geographical and occupational immobility. Firstly for geographical, there have been reforms in the housing market, with an increase in the supply of affordable housing. More over there has also been subsidies given to workers where there has been a shortage of occupations, for example Nhs and teachers. To reduce occupational immobility, the government has set up training schemes to equip workers with new skills, which will boost their confidence and help them to enter new job markets. Both methods will help off balance the market failure created by a free market.

Conclusion What is meant by market failure and how can the government attempt to correct it? The free market causes various scenarios in which there is a miss allocation of resources and causes market failure. It is then down to the government to correct and they do this through many different techniques( see table one ). However the problem with the government attempting to correct them, is that they are hardly monitor once they have been set up. As well the success of the scheme is sometimes never as successful as planned, which lead to government failure and means there has been miss allocated resources.

Furthermore the schemes have to go through legal process, which takes time. Carrying on this point there are a lot of external factors, which will also effect the process of the scheme which were not for seen by the government. For example occupational immobility, it maybe be harder for some workers to actually learn new skills, therefore taking more time and resources. All in all in my opinion, government intervention on market failure has its successes as well as its failures, and there will never be a perfect market due to the fact there are too many external factors with will unbalance the market and sooner or later will cause market failure.


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  • University/College: University of Arkansas System

  • Type of paper: Thesis/Dissertation Chapter

  • Date: 12 September 2016

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