The Major Reasons for Market Failure - Research Paper Example

The Major Reasons for Market Failure Abstract If the production and use of goods is not efficient or effective in the market, it is a market failure condition which is not desirable either for the manufacturers or the consumers. Market failures can be caused by many factors like the current economic recess, governmental policies, changing customer behaviors etc. Governments often try to tackle market failure condition using measures like adjustments in taxes, subsidies, bailouts, wage and price controls, and regulations. While some economists believe that the government can improve the inefficient markets, some others strongly disagree with it. Market Failure It is difficult to have a perfect market all the time. Market activities can fluctuate some times within the limits and sometimes beyond the limits. When market activities vary beyond certain limits it could be market failure state. “If a free market gives us too many of some type of good, or too few of another type of good, we are either over-allocating or under-allocating our resources. In the case of market failures we are productively inefficient and/or allocatively inefficient” (Market Failures, http://elmo.shore.ctc.edu/economics/market.htm) The availability of goods in the market should have a balance between the supply and demand which is the ideal market condition for both the consumers and the manufacturers. If the market experiences scarcity of a commodity which was highly demanded by the consumers or the market experiences excess of a commodity with less demand, in both the cases, the market failed to perform adequately. Market failures can be classified into five major categories; market power, externalities, public goods, equity and macroeconomic stability (Market Failures, http://elmo.shore.ctc.edu/economics/market.htm). When a manufacturer has control, power or monopoly over the market, he can do anything to maximize his profits or to exploit the market. For example, Microsoft has monopoly in the operating system market and they can do anything to control the OS market. At the time of writing this paper Microsoft has launched their new OS Windows 7. Most of the computer users in the world are using either Windows XP or Windows Vista at present. They will be forced to purchase the modified version of Vista, the Windows 7 in order to make their system updated; otherwise they will face compatibility problems in future. Thus Microsoft forces the consumers to purchase their new product because of their immense market power. An externality means that there is some third, nonparticipating, party to an exchange who is either involuntarily paying a cost or receiving a benefit (Market Failures, http://elmo.shore.ctc.edu/economics/market.htm). Externality in economics may give benefits to some of the economic agents whereas it may affect adversely others. For example, heavy industrialization is countries like America may be beneficial to the industrialists and the public in America. But the toxic gases coming out from the industries may not stay in the American atmosphere alone. It can pollute the atmosphere of the neighboring countries also. In other words, though American public and the manufacturers were able to enjoy the benefit of industrialization, outsiders who don’t have any benefit of the economic developments in America may also force to experience the side effects of the economic activities happening in America. Public good is the property of the public which provides utility to the public who pay for it. For example, India has recently successful in proving the presence of water in moon using their “Chandrayan” mission. NASA has used the information collected by “Chandrayan” to conduct further experiments in moon in order to study the possibility of utilizing the water resources discovered in the moon. For a third country like, China or Russia the findings of “Chandrayan” or NASA provides immense benefits in their studies about moon which they yielded without spending any money on moon exploration. India and NASA spent millions of dollars for their moon exploration projects which can be utilized by others as well. In other words, the information collected from such explorations is a public property irrespective of who spent money for such explorations. In such a scenario, most of the countries will refrain from exploring the moon like planetary objects if such explorations not yielding any immediate benefits. In other words, space exploration or moon exploration like public projects are not yielding any immediate benefit to those who spends millions of dollars, but others are getting the same information without spending a single dollar. In this regard, if we consider moon exploration as a market, it is a market failure for the investors at least for the time being. ‘Equity, in a market system is a state in which the income distributed unevenly. At times this unevenness does not seem fair. For example, a five year old child commands a very low wage in an unfettered (unregulated) labor market. This is not the child’s fault, but that child would be poor in a pure market society. The government transfers income from income earning households to non- or low income earning households. While the first three market failures are concerned with the "what and how" question, this one addresses the "for whom" question’ (Market Failures, http://elmo.shore.ctc.edu/economics/market.htm). Thus the child forced to take the assistance of his parents. Another important reason for market failure is due to the economic variations in the market or macroeconomic stability. The current economic crisis was an unexpected one and many business groups failed to take precautionary measures. Even the big firms like AIG, Lehman Brothers has collapsed because of the sudden dip in the market economy. Moreover, many people lost their jobs which increased the unemployment problems drastically. Problems of information and Problems of expectations can also cause market failure. (Goodwin Neva, Market Failures, The Aspen Institute Center for Business Education's Corporate Governance and Accountability Project, http://www.caseplace.org/d.asp?d=2793) For example, the current economic recess has resulted in the destruction of the share market. The share values have come down a lot. Some people expect that the market will improve in the near future itself and it is better to invest in shares at present. Information from different parts of the world is justifying the above belief. But at the same time, the above expectations may or may not become right. Sometimes the market may decline even further. The information may not be the right or may not interpret well. In any case the investor may sometimes lose money if he fails to interpret the information correctly and to anticipate the future of the market properly. “Government intervention may seek to correct for the distortions created by market failure and to improve the efficiency in the way that markets operate Pollution taxes to correct for externalities  Taxation of monopoly profits (the Windfall Tax)  Regulation of oligopolies/cartel behavior  Direct provision of public goods (defense)  Policies to introduce competition into markets (de-regulation)  Price controls for the recently privatized utilities” (Tutor2u, Economics of market failure, http://tutor2u.net/economics/content/topics/marketfail/market_failure.htm) Government is the only entity which can control the market activities effectively by adjustments in their policies and price control measures. For example monopoly is not a good market condition for the consumers. If the government fails to control the activities of such firms, the consumers will suffer a lot. Irrespective of whether the market fails or improves, the government needs to have a close look always at the market in order to fine tune the market conditions in order to conserve the interests of both the consumers and the manufacturers. Sub topics – GDP, Unemployment and Inflation Gross Domestic Product (GDP) is the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports.(Investorwords.com, GDP, http://www.investorwords.com/2153/GDP.html). GDP is the fundamental measure of a country’s economic performances and the standard of living of the people. If GDP is positive then we can assume that the country’s economy is in the growth phase or accelerated whereas when GDP becomes negative the country’s economic growth will be retarded. The "unemployed" comprise all persons above a specified age who during the reference period were "without work", "currently available for work", or "seeking work" (Piana, 2001, UNEMPLOYMENT http://www.economicswebinstitute.org/glossary/unemploy.htm). Unemployment rate is another economic factor which gives us a measure of the economic progress of a country. In most of the developed countries the unemployment rate would be much more less than that of the developing or underdeveloped countries. “Inflation is defined as the increase in the amount of money and credit in relation to the supply of goods and services. Often, inflation is erroneously defined by the effect that it has on the economy. When people notice that gas, food, and lodging is getting more expensive, they often label that phenomenon inflation. Rising prices, however, are really just the result of inflation” (Definition of Inflation, http://www.yourdictionary.com/dictionary-articles/Definition-of-Inflation.html) Inflation is another economic indicator which gives us a measure of the economic status of a country. Economist believes that a higher or a lower inflation rate is not advisable for a country. Inflation rate should be between certain limits in order to keep the economic development in the right path. Suggested areas of further research The current economic crisis has taught the economists a lesson. Lot of economic concepts was proved to be wrong. In fact the American financial institutions never thought that a market like America may collapse as it happened today. Their calculations based on the traditional economic concepts were gone wrong. A more comprehensive research and study is essential framing meaningful economic theories and concepts as per the characteristics of the current world. Inflation is often a contradictory topic in economics. The optimum rate of inflation for economic progress is still controversial because of the difference in opinions among economists. In any case economists are unanimous that a negative inflation is not good for economic growth whereas alarmingly higher rate of inflation is also not good for the economy. So economists need to deeply research further to identify the ideal inflation rates for the economic growth of a country. Gross Domestic Product, as everybody knows can be generally defined as the income minus expense. A country which has less income and less expense may have the same GDP like another country which has high income and high expenses. In other words, a country with less economic activities can have the same GDP as that of a country with high economic activities. So we cannot say that two countries with same GDP have same economic abilities and same status. In short, GDP not necessarily reflect on the economic abilities of a country and further research is needed to define GDP more appropriately to represent it as an economic indicator. Works Cited 1. Goodwin, Neva. “Market Failures”. The Aspen Institute Center for Business Education's Corporate Governance and Accountability Project. 23 October 2009. 2. Investorwords.com. “GDP”. 23 October 2009. 3. “Market Failures”. 23 October 2009. 4. Piana, Valentino. 2001. “UNEMPLOYMENT”. 23 October 2009. 5. Tutor2u. “Economics of market failure”. 23 October 2009. Read More