People, Profit, and Price: The Factors That Contribute to Market Failure - Assignment Example

?Task Q A-What is meant by the term “ceteris paribus”? The Latin term ceteris paribus refers that all the relevant variables are held constant, except the ones being studied. The phrase literally means that "the other thing being equal". It indicates a hypothetical situation where variables are considered as constant, but many change in real world (Mankiew, 1998, p.66). B- Explain the term “paradox of poverty “in the context of agricultural production? Paradox of poverty occurs when farmers become poorer due to their tendency towards planning production at large scale. The elasticity of demand for agricultural products is tremendously low, therefore, large scale production in agriculture sector generates surplus in the market and considerable fall in price (Jain and Ohri, 2007, p.89). Q2: What do you mean by income elasticity? Identify the symbolic form of income elasticity. Income elasticity of demand refers to the reaction of demand to change in consumers' income. In other words, it is the extent of change in demand to a change in consumers' income. Income elasticity of demand is calculated by the ratio of percentage change in demand to income (Anon., 2005, p.22). According to Anon (2005, p.22) it is represented as: Income Elasticity of Demand = In symbolic form, eY=  Where eY =Income elasticity of demand; Y =income of consumer, Q=quantity demand, Y=proportionate change in income Q: 3 what is mean by production function? What is the use of production function in production analysis? The production function refers to a technological relationship between input and output (Anon., 2005, p.50).It indicates the output of a business, industry, or economy for the input. When it comes to the use of production function in production analysis, assume a firm that uses N amount of inputs, such as, machinery, labor, and materials, for producing a single output. Production function (q=f(x)) is used to summarize the technological possibilities of that firm. Here, q represents the output and x=(x1, x2…xn)' is an N?1 vector of inputs (Coelli, Prasada, Christopher and George, 2005, p.12). Q: 4 what are the characteristic features of free market economics? How are the central problems of resource allocation solved in such economic? Characteristics of free market economy include: consumers, producers, private owners, and government are primary actors, three actors (consumer, producer, property owners) are driven by self-interest while government is driven by social welfare, all factors of production are the property of private owners, owners have the right to buy and sell through market mechanism, competition exists when there is freedom to allocate resources. Decision making is decentralized since individual economic actors are free to allocate their resources. Resource allocation is defined by individual economic agents. Economic actors pursue their interest but resource allocation is in interest of society (Anderton, 2006, p.22). Q: 5 explain the term “economic costs”? How do these differ from accounting costs? Use examples to illustrate your answer The economic cost (EC) is greater than the accounting cost (AC) because EC includes both explicit accounting cost and implicit cost which is the value of owner's personal resources.EC incorporates implicit costs that could have been gained when same resources are invested somewhere else. If a couple decides to invest $100,000 on building for opening a restaurant. Implicit costs would be 3 percent or $3,000 or the money earned from some other investment. It is because of different rate of return in mutual funds (9 percent) and capital investment (6 percent) on $100,000(Musgrave and Elia, 2001). Task: 2 Explain the causes of market failure. Should market failure always invite government intervention? Discuss the different ways in which government intervene in the market. Give example in support of your answer? Introduction "Market failure is a blanket term used by economists to describe situations in which markets might not work and/or markets might work to produce socially undesirable outcomes. The existence of such undesirable outcomes has provided governments with a justification for market intervention"(Grant and Chris, 2000, p.89). It refers to the failure of market economy to make efficient allocation of resources (Lipsey and Chrystal,2007,p.277).According to Morey (2012) markets don't tend to achieve efficiency, if they do, without interruption, it results in an inefficient equilibrium which is called market failure. The market failure occurs in the allocation of numerous natural and environmental resources that makes overall resource allocation inefficient (p.1).Primary causes of market failure include, common property resources, externalities, provision of public commodities, imperfect competition, lack of markets, and capital market distortions, and even, government intervention. Any resource is called common property when no one owns it effectively. There are very few common-property resources in the world and access to them is nearly uncontrollable. For example, a common-property fishery, oil field, air space, wilderness area, rain forest, and aquifer can lead to market failure (Morey, 2012). Externalities are another cause that leads to market failure. External effect occurs when one or more economic agent is incorporated as a direct clash in the utility or production functions for other agents. It exists when one economic agent is directly influencing one or more economic agents (Morey, 2012).While defining externalities, Morey (2012, p.10) explains that there is an externality when economic agent(s) act directly affects other economic agent(s) which can potentially make one of the parties better off without contributing to make the other worse off. Moreover, there is no externality if the producer of external influence takes corrective initiative. Public commodities have property that can be consumed by multiple agents. Public good refers to a good or service that is non-rivalrous or non-excludable. Non-rivalrous goods or services indicate that the commodity is noncongenstible; therefore, one agent's consumption of certain unit is not depleted by another agent's utilization of the same unit (Morey, 2012). Non-excludable are the goods or services from which it becomes difficult to separate agents' from its benefits. When problems arise, no one pays for what they can get without paying. Public goods are not provided by private firms since they can't charge for it, therefore, government provides public goods, such as, public libraries and street lamps (Morey, 2012). Excessive market power in resource and goods market also leads to market failure. There is no perfect competition in real markets, and free market forces do not end up in efficient allocation of resources. Monopoly and oligopoly are examples of imperfect competition. Producing less than society's need is the way to make more profits for monopolists. A monopolist has the ability to control the total production and produce lesser than the competitive market would have produced, controlling output increases the profits (Morey, 2012). Resources cannot be allocated sufficiently if the market does not exist for some of the resources. Markets needs sufficient property rights, enforcement, and better transaction fees for traders. Absence of these will result in lack of market. It implies that market inefficiencies can be reduced by creating future markets (Morey, 2012). Distortion in capital markets is another cause of market failure. From an efficacy perspective, market rate of interest is either too either too high or too low. A capital market is where money can be borrowed. It is crucial to distinguish between market failures in capital markets and discrepancy between market rates of interests and the social discount because of intergenerational equity problems (Morey, 2012). According to Zerbe and Howard (2000) the idea of government intervention is more of empirical nature rather than theoretical. Moreover, there is no substantial theory that can define the role of government in mixed economy (p.13). Very often, market fails and invites various kinds of government interventions. It is widely accepted that invisible hand is not an ideal choice and government intervention becomes a necessity most of the times. However, this idea is often misused for justifying dislocated government interventions. It leads governments to rectify visible outcomes rather than focusing on the direct causes of failure. In this way, government intervention proves to be another failure (Lee, n.d.). It is common perception that governments intervene when markets fail. Some scholars argue that market is the product of the conscious and sometimes aggressive government intervention (Polanyi cited in Lee, n.d.).They claim that resource allocation by market is very disturbing; therefore, modern democracy must handle the market function. However, most of the government interventions turned out to be failure. Some examples of government intervention may include but not limited to: employment protection legislation, cross subsidization in regulated industry, unemployment insurances, affirmative action, democratic control of economy, and social welfare programs through individual and collective responsibility (Lee, n.d.). Lee (n.d.) concludes that most of the government interventions attempt to rectify income distribution directly rather than reinstituting the property right protection. Therefore, it ends up in government failure. With helping the needy part of intervention, governments bring the arbitrary intrusion on private property that hinders the smooth operation of economy. Consequently, demands for expanding the base of social welfare system lead to economic slowdown and blunt employment. Conclusion Market failure is a term that refers to the failure of market economy due to inefficient allocation of resources. Major causes of market failure include, common property resources, externalities, provision of public commodities, imperfect competition, lack of markets, and capital market distortions, and even, government intervention in most cases. Government intervention is not always desirable as most of the interventions in past turned out to be failure. The cause of government interventions failure is government's attempt to rectify income distribution directly rather than reinstituting the property right protection. Some examples of government intervention include employment protection legislation, cross subsidization in regulated industry, unemployment insurances, affirmative action, democratic control of economy, and social welfare programs through individual and collective responsibility. References Anderton, A., 2006.Economics (3rd ed.).London: Dorling Kindersley. Anon.,n.d. Together with Economic Applications. New Delhi: Rachna Sagar Pvt. Limited. Coelli,T.J.et al.,2005.An Introduction to Efficiency and Productivity (2nd ed.).New York: Springer. Grant,S.,and Chris,V.,2000.Economics in Context. Chicago: Heinemann. Jain,T.R. and Ohri,V.K., Priciples of Microeconomics. New Delhi: V.K. Publication. Lipsey,R.G., and Chrystal, K.A., Economics(11th ed.).New York: Oxford University Press. Lee,S.H.,n.d. Market Failure and Government Failure.[online] Seoul National University. Available at: < https://docs.google.com/viewer?a=v&q=cache:XFNIAZMRTHAJ:www.en.kyushu-u.ac.jp/aslea/apapers/Democratic%2520control%2520of%2520market.doc+&hl=en&gl=pk&pid=bl&srcid=ADGEESgHzpFdgmre1I5qgTzWsVJ3Cu_aFhUoQYkDqOC19cW6Lmswzdkt3riSkTiIg7aIwLaP7w-YeGdUO79OjoCOtEpOJ0Nf1WZp4EM5WRajGYxHTZxTVpiUlaGG61Td89yaxY1SZr0E&sig=AHIEtbTvoRYRuivfVAifN0SS7wLJwX0SpQ> [Accessed 29 June 2012]. Morey, E.2012. An Introduction to Marketing Failures.[online].University of Colorado.Available at: < http://www.colorado.edu/Economics/morey/4545/introductory/marketfailures.pdf> [Accessed 29 June 2012]. Mankiw,N.G., 1998.Priciples of Microeconomics. Orlando, FL: Michael Steirnagle. Zebre Jr.,R.O., and Howard,M.,2000.End of Market Failure. Regulation [online] 23(2) Available through: Social Science Research Network database [Accessed 29 June 2012]. Musgrave,F., and Elia,K.,2001.How to Prepare for the AP: Microeconomics/Macroeconomics Advanced Placement Examination. New York: Baron's Educational Series, Inc. Read More