Why markets generally fail to achieve social efficiency - Essay Example

?Running Head: Social Efficiency & Markets Social Efficiency & Markets [Institute’s Social Efficiency & Markets Social efficiency crop up when resources are consumed in the most efficient and well-organized manner. Social efficiency to produce or consume is more, if the marginal benefits to society (MSB) of producing or consuming any given product or service exceeds the marginal cost to society (MSC). On the other hand, if the marginal cost to society exceeds the marginal benefit, then the social efficiency is low in that case. Whereas, when MSC and MSB are equal, it is referred to be at an optimum level (Suneja, pp.147, 2000). It is very difficult to achieve social efficiency and real markets fail to accomplish it because their marginal social costs do not equal the marginal social benefits. There are a number of reasons behind market failure. Externalities: “A market is not likely to lead to market efficiency if the deeds of the producers or consumers affect people other than themselves” (Sloman & Sutcliffe, pp.430, 2004). Externalities occur when society fails to make adequate compensation for the production of goods and services as well as for the consumption of these products. This is attributable to the ‘spillover effect’ this leads. Since the pricing system does not account for the marginal social costs and benefits that are attached to the compensation of these products, externalities exist, which may often lead to market failure. Social cost is the addition of private cost and the externalities. Let us take an example of a chemical industry. If a chemical industry release by products into a river or atmosphere, it is creating negative externalities that inflict higher social cost on other industries in the form of health and other costs. When the marginal social costs are more than the private marginal cost, it is the evidence of the presence of the negative externalities. The producers who are mainly interested in increasing their profits consider only the private costs and benefits cropping up from their goods. However, there is a more elaborate effect that consumption of these goods and services has, which one can truly assess only after considering the external costs. However, since prices often fail to do so, they fail to achieve the socially efficient level of production. The producers generating the externalities mostly do not take in their calculations the effects that may lead to market failure. Consumers can also be responsible for negative externalities due to pollution, noise pollution, trash on streets, destruction of public property, negative externalities created by crime, etc. In circumstances like these, the consumers are not aware of the marginal social costs, and judge the utility only by the high private benefit of consumption. Consequently, it is only evitable that they will over-consume the good. On the other hand, if there were no such externalities present, there would be an optimum allocation of resources, instead of market failure. This means that the scarce resources available in the world will be employed in the most efficient manner in order to satisfy the demands of the consumers (Grant & Vidler, pp.121, 2003). Merit and demerit products: Those goods, which are most likely to create positive externalities, are merit goods/products. These goods are desirable for the society and the society considers that such products and goods should not be restricted to those who are willing or are able to buy (Geradin et al., pp.27,2005) Merit goods increase the social rate of return while demerit good or products decrease it as demerit goods generate negative externalities when consumed. Alcohol and other various drugs are demerit goods. The consumption of such drugs may cause negative externalities and lessening in social economic welfare. The government mostly tries its best to reduce the utilization of demerit products. Customers are more likely to be unaware of the negative externalities that these products create that lead to market failure. Merit good are also likely to cause market failure if the government leaves them to the private sector wholly that may lead to under-consumption. One of the reasons behind this problem is that people do not value the social benefits from the consumption of merit goods and services like health services. Public goods: The ‘free market’ will either not produce this category of goods at all, and if it does, it will do so much less than needed. This fact will not be affected by the fact that the market is free or not (Suneja, pp.150, 2000). Public goods lack the exclusion and distribution characteristics of private goods, and become public goods by default (Musgrave & Kacapyr, pp.83, 2009). Public goods have opposite characters than that of public goods. Public goods cannot be limited to those who have bought it; therefore, non-payers can also enjoy this kind of products. The availability of such product does not reduce due to consumption. The most common public good is streetlight that is providing light to every one without payment. Now, the question arise that why is there market failure with such products? The answer is that the private companies do not prefer to provide public goods to the people, as there is no profit for them in such action. Market imperfection: This imperfection occurs when the market does not fulfill the conditions necessary for it to qualify as operating under perfect competition (Ghai & Gupta, pp.208, 2002). Market flaw or imperfection is most likely to cause market failure. One of the major causes of market imperfection is the monopoly power of firms in the product market. The consequences of monopoly are: Under monopoly, the prices of the goods are higher while output is lesser as compared to the competitive market. Monopoly creates a net economic welfare failure of customers and producer leftovers. The price of the products exceeds the marginal cost causing inefficiency. The other major cause of market imperfection is the unionized labor in the labor market. The presence of market union cause increase in the wages, which leads to market failure in achieving social efficiency. Inequality: The inequality of economy is also likely to cause market failure. There are a great number of countries, where some people are living in material comfort and others in poverty due to unequal distribution of resources. This condition applies in market economies. Here, high incomes enable people to obtain output in an unfair proportion. This distribution, while possibly within the description of ‘efficient’, may be inequitable (J. Carbaugh, pp.189, 2010). The government can play a positive role in such situation by reducing inequality via change in taxation. Factor immobility: Factor immobility is one of the most important causes behind market failure in acquiring social efficiency. There are two major types of factor immobility: Occupational immobility Geographical immobility The occurrence of occupational immobility is due to the difficulties in the way of mobility of aspects of production among various sectors of economy. According to experts, “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 economically efficient” (Riley, pp.30, 2006).This is also a major reason behind the unemployment in the area. This type of immobility is very common amongst employee. Once a worker has trained herself for once specific line of work, it will be difficult for her to find a job elsewhere, since her extremely specific skills will not be in high demand (Riley, pp.30, 2006). These circumstances show a wastage of resources that is likely to cause market failure to achieve social efficiency. Geographical immobility causes barriers to move from one area to the other for getting employment. This factor also causes market failure. Ignorance and uncertainty: The concept of perfect competition is an ideal one. This is because in the real world, there is ignorance and uncertainty. Therefore, the condition of perfect information cannot be fulfilled (Suneja, pp.150, 2000). People do not have enough knowledge of the relationship between the marginal costs and marginal benefits. Mostly firms are ignorant of the opportunities they can get in a market that is most likely to cause market failure. Lastly, markets can achieve economic efficiency quite easily but it is difficult to acquire social efficiency. According to experts, “Economic efficiency refers only to the fulfillment of individual preferences backed by money and capable of satisfaction through commodities, social efficiency also recognizes goals adopted by society through government that may be attained only via collective action” (Clark, pp.7, 1998). References Clark, Barry Stewart. 1998. Political economy: a comparative approach, second edition, USA: ABC-CLIO. Geradin, Damien, Munoz, Rodolphe & Petit, Nicolas. 2005. Regulation through agencies in the EU: a new paradigm of European governance, USA: Edward Elgar Publishing. Ghai, Pankaj & Gupta, Anuj. 2002. Microeconomics Theory and Applications, Delhi: Sarup & Sons. Grant, Susan & Vidler, Chris. 2003. Heinemann economics for OCR, UK: Heinemann. J. Carbaugh, Robert. 2010. Contemporary Economics: an Applications Approach, 6th edition, USA: M.E. Sharpe. Musgrave, Frank & Kacapyr, Elia. 2009. Barron's AP Microeconomics/Macroeconomics, USA: Barron's Educational Series. Riley, Geoff. 2006. OCR AS Economics, Course Companion, West Yorkshire: Tutor2u Limited. Sloman, John & Sutcliffe, Mark. 2004. Economics for Business, 3rd edition, India: Pearson Education. Suneja, Vivek, 2000. Understanding business: a multidimensional approach to the market economy. Markets, New York: Routledge. Read More