Perfect Market and Market Failures - Essay Example

Perfect market and market failures: A study The perfect market is a market where the trade of goods and services occur in the most suitable manner such that there is maximum benefit for the producer, consumer and the society as a whole. But in reality it is very difficult to see the perfect market. Market failures occur due to several reasons and some of its examples are traffic jam, credit crunch, etc. The present essay intends to study the concepts of a perfect market and factors that could lead to a market failure. It is also intended to assess traffic jam and credit crunch as examples of market failures. A perfect market is a theoretical concept on the basis of following assumptions. There are a large number of buyers and sellers in the market for a particular product and there is perfect freedom for entry into as well as exit from the market. There is sufficient supply of the product in the market and the purchase made by any single individual would not affect the market. The product sold is homogenous in all parts of the market and all the buyers and sellers are having complete information regarding the prices in different parts of the market (Cunningham, 2001). The following are the attributes of a perfectly competitive market (Hardford, 2006). 1. The producers of a product, whether farmers or companies or any other organizations, who are not putting their resource into complete use or wasting the resources, would fail in their business. The same thing happens if they produce their product more than the demand for that product or produce the product with a wrong technology. In a perfect market all products are produced in the most competent manner. There is no wastage of resources and the products are produced with minimum costs and in exact quantity as required by the market. 2. The companies would make the right product preferred by the customer for a given price and the price equals the cost of production. This means that both producers and consumers are satisfied. 3. Only the required amount of products is produced so that there is no surplus or deficit. If there is surplus, then the price would reduce and if there is deficit, the price would go up. In other words the amount that is produced would be equal to the demand of the product. Then the price of the product would be equal to its cost and would be equal to the worth attached to it by the customer. 4. Other assumptions include no taxes or public goods and other externalities. When the production as well as use of goods and services in a market is not efficient, it is called market failures (Krugman and Wells, 2006). It occurs usually when the individual's interest is different from the interest of the society. In most cases it calls for government interventions to solve the situation. There are many reasons for market failure. When a producer of the goods or services gain market power in such a way that he can control the trade of the product and impedes the interest of other traders, then a condition called imperfect competition occurs. This can be monopoly, monopolistic competition, monopsony, cartels etc. Another condition that could lead to market failure is the existence of either positive or negative externalities. Yet another reason is the presence of public goods in the market. Market failure can also occur when the resources are common (Krugman and Wells, 2006). One of the most important examples of a market failure is traffic congestion. Roads are public goods and a resource that is common to all. In the last two decades there has been a tremendous increase in the number of vehicles produced and used and there is no corresponding increase in the road space (Harford, 2006). So the demand for road space is more than its supply. This in turn results in traffic congestion. Traffic congestion results in longer time required to reach a place, slowing of the speed of the vehicle, which would increase cost of driving and this could seriously affect trade. When the traffic comes to a complete stop it is called traffic jam. Traffic congestion/jam affects the market or the economy as a whole in different ways. It is a waste of time by the driver or the passenger, which could have been used in a more productive manner if there was no such congestion. People would not be able to be punctual in their activities and this could lead to personal losses, loss of business, etc. More time has to be allocated for travel and less time for work. Increased use of fuel would not only affect the pocket of the driver, it would affect the environment also, causing air pollution and contribute to global warming. Traffic congestion can be solved to a great extent both by increasing the supply of road space by proper planning and construction of the road and a better planning of the city. It can also be solved by restricting the use by enforcing restriction in the form of fees, tolls etc (Button and Verhoef, 1998). Thus it can be seen that traffic congestion is an example of a market failure and is a result of planning failure. A credit crunch is a situation where the banks or the lenders reduce the availability of loans or credit and the main reason is the anticipated loss of value of the collateral. It can occur due to government interventions suddenly increasing the reserve requirements, or fall of price of property, solvency of banks etc. Generally it is the result of ruthless lending over a period of time resulting in the accumulation of bad debts (Cooper, 2008). In a free market when the supply of money and credit is not sufficient credit crunch occurs. Thus this is also an example of a market failure and here, the reason is mainly government interventions (Randall, 2009). When the government reduce the rates of federal reserves, the supply of money would increase which in turn result in increase in price of all commodities as well as credit. This would in turn result in giving out loans, which are riskier, at low prices. These loans, in most cases would not be repaid, thus breaking the backbone of the banking system. The banks would then be forced to restrict the conditions on which loan would be sanctioned and thus financial crisis or credit crunch sets in. Thus this also an example of market failure and one of the reasons behind is planning failure. Thus it could be seen that a perfect market is a market where the supply of good and its demand equals. But due to various reasons, such a condition fails to exist and result in market failure. Traffic congestion occurs when the supply of road space is less than the demand for it. This is an example of market failure and through proper planning, this problem could be solved to a great extent. Similar is the case of credit crunch. When the supply of money is less than the demand, financial crisis or credit crunch occurs and banks hesitate to lend money to the people thus affecting the free flow of trade. This problem also could be solved to a great extent by proper planning by the government. References Button, K. J. and Verhoef, E. T. (1998) Road Pricing, Traffic Congestion and the Environment: Issues of Efficiency and Social Feasibility. Cheltenham, England, p 316. Cooper, G. (2008) The Origin of Financial Crises: London, Harriman House. p 200 Cunningham, L. A. (2001) How to Think Like Benjamin Graham and Invest Like Warren Buffett. McGraw-Hill Professional, p. 22 Harford , T. (2006) The Undercover Economist. Published by Oxford University Press US p.62-70 Krugman, P. and Wells, R. (2006) Economics, Worth Publishers, New York p. 850 Randall, E. (2009) Do people who consider the credit crunch a "market failure" just not know what they're talking about Accessed online at http://answers.yahoo.com/question/indexqid=20081017075841AARklKK Read More