Market Failure and Government Intervention - Coursework Example

Market Failure and Government Intervention Introduction Market failure occurs when there is inefficient allocation of goods and services in a free market. Market failures create unfair competition where some producers enjoy monopoly power while others suffer due to their market predominance. The market inefficiencies should be controlled to promote fairness and balanced economies. The government should intervene in controlling market failure so as to promote equal allocation of resources in the economy (Hetzel, 2012). Causes of Market Failures Market Inefficiency Market inefficiency exists where the companies produce inadequately. There are 6 types of market inefficiencies. Pareto inefficiency developed by Vilfredo Pareto: means that the economy does not produce the maximum goods and services required from its resources. Productive inefficiency is where the business does not produce from its lowest unit-cost. X inefficiency occurs when the firm’s output is not at its greatest. Allocative inefficiency exists where the consumers pay inefficient prices for commodities. Dynamic inefficiency occurs when companies are less technological progressive due to lack of incentive. Lastly, Social inefficiency is when the price mechanism ignores the benefits and costs associated with the economic exchanges (Hetzel, 2012). Monopoly Monopoly is the exclusive predominance in the supply or trading of a particular commodity or service in the market. Monopoly can exist where a company has large economies of production. If the company’s cost of production reduces while the scale of its business increases, there output production would be maximized. The existing companies will become bigger by having costs advantages over their rivals and the new entrants. Some companies can also have monopoly power through predatory power; which involves dropping the prices too low so as to prevent existing and potential rivals into the market. Limit pricing is also a monopoly mechanism where businesses set prices below the average costs of the new entrants (Hetzel, 2012). Some companies can perpetually have the ownership of some scarce resources over time. The early entrants may tie up the market of some existing limited resources so as to prevent other entrants from exploiting the resources. Heavy advertising expenditures of the existing monopoly firms can discourage the new entrants from participating in the particular market. Brand loyalty and the company’s loyalty schemes can deter the existing or potential rivals from competing in the same industry. The consumers’ are normally attached to the company, adding to the difficulties of the potential firms. Some retailing firms have exclusive partnerships with other suppliers which can prevent competition from other existing retailers. Vertical integration is also another limiting factor that can prohibit competition in a given environment (Hetzel, 2012). Public Goods Market failure can occur if there is lack of production of some essential commodities to the public. These goods can fail to exist because; there is demand but no supply. These goods lack supply in the free market due to their three unique characteristics. They are non excludable; that is, when they are supplied it is impossible to deny others the benefit of its functionality. An example is the street light which is available to everyone. Public goods are non diminishable even if they are used by one or many individuals. If the product or service is consumed by one person, the remaining stock does not reduce for others to use as compared to a private good. This principle is also known as non rivalry because the consumers do not compete for their accessibility due to their lack of inadequacy in terms of use. Again the goods are non rejectable, hence the consumers are compelled to consume it. Consumers cannot reject the services of the armed forces in terms of protection from external attacks or the benefits of a street light (Great Britain, 2009). Incomplete Markets In incomplete market, some conditions in the market formation exist but not all of it. In such a situation some entrepreneurs may be motivated to join because there are chances of making a profit. Contrary, the startup companies will only satisfy a smaller portion of the total demand. Examples of incomplete market goods include merit goods and quasi public goods. The quasi public goods resemble the public goods only that they have different characteristics. Free markets for public goods cannot exist for example in infrastructure, but in quasi public goods, there is the possibility of free markets because they could satisfy part of the total demand. One of its distinct characteristic is that it can be rejected. The consumers have a right to reject it and can however fail to consume it. They are also partly excludable meaning some consumers can be rejected from using the good or the service; an example is a bridge (Great Britain, 2009). Negative Externalities Negative externality is where an external third party suffers a loss due to an inefficient economic transaction. The producers and the consumers are normally the first and second parties in any business transaction, any other individual, property owner, indirectly affected resource, or the organization; are usually the third parties. Externalities are sometimes termed as spillover effects while the negative externality is also known as external cost (Great Britain, 2009). The externalities frequently occur in circumstances where the property rights over some resources or assets, are uncertain or have not yet been allocated. For example, the oceans are not privately owned or owned by anyone whatsoever; hence ships may pollute the water body without fear of being prosecuted. Hernando De Soto, a Peruvian economist is renowned for his ideas on the importance of creating property rights. He explains that for any successful economy to develop the property rights need to be spread widely. Therefore, in case the property rights are not properly defined, the market failure is bound to happen because the producers and consumers are not held accountable (Bounfour & Miyagawa, 2015). Unstable Prices Markets can fail to stabilize due to changes in the economy. The changes are due to; the unstable prices, lack of bargaining power to the large supermarket chains and the fall of long-term incomes. Farming incomes have gradually fallen due to the gradual increase in food supply. The increase in food supply has been accelerated by the new technologies which have boosted the farm yields. There is also the entrance of new markets for example Vietnam in coffee production. Additionally, there is also the loss of power; where large supermarket chains can dictate the farmers’ prices. Majority of the commodity markets experiences short-term instability. For example movement of cocoa prices is common among commodity markets which normally tend to experience considerable volatility. The price movements occasionally imply the changes in the conditions of supply due to changes in the weather patterns like el Nino (Bounfour & Miyagawa, 2015). Inequality Market failure can result due to unequal distribution of income. Due to the market failure some individuals may fail to have any revenue at all. Revenues are realized when people hire or sell out their factors of production to other people. The wide income and wealth variations between the different classes of people in the economy, creates a wide gap between the wealthy and the poor individuals. Many societies view income disparities as undesirable and unacceptable. The issue of value judgments usually comes into play whenever there is a discussion in the allocation of wealth or income in the country (Bounfour & Miyagawa, 2015). Lack of Property Rights Markets lack efficiency when there is nonexistent of property rights. Direct or indirect resources which are used during exchanges have no specific owners and are available for use by anyone. Lack of property rights can lead to negative effects like opportunism. People can take advantage of exploiting other people’s properties’ whether physical or intellectual, due to the absence of private ownership. It can also lead to vices such as misuse of the limited resources. The lack of moral hazard can make people to be careless and wasteful. The resources can also be overused due to lack of concern by some individuals. It can result to the rain forests depletions or traffic congestions which are all caused by the absence of property rights. Absence in property rights can also cause the exhaustion of natural resources or even the exhaustion of the environment itself. The environment is also a limited resource since it cannot be entirely protected by the establishment of property rights. Further, lack of property rights can result to lack of economic development (Bounfour & Miyagawa, 2015). Information Failure Market failure can come about due to lack of perfect knowledge by participants in an economic exchange. There is also another scenario where one of the participant’s knows more than the other partner in an economic exchange. Such a situation is usually known as asymmetric. In information failure, there is the misallocation of limited resources where the consumers may end up paying so much, while the firms produce so little or so much at the same time. Markets perform best if there is perfect information, where it is evenly distributed between individuals in a transaction. Therefore, asymmetric information is an economic challenge because one individual can exploit this knowledge unfairly and exclusively (Bounfour & Miyagawa, 2015). When the parties to an economic exchange are ignorant of some issues in a transaction, like the product’s quality they are purchasing, the individual is compelled to make an assumption of the commodity based on its price. An example is when a purchaser may perceive a product is of poor quality in case it has a low price and it is of high quality in case it has a higher price. Government Interventions Taxation In the labor market, the government can control personal incomes of people through the use of tax and benefit systems. The progressive tax system imposes proportionately more taxes to the high earning people and proportionately less taxes for the lower earning people. By this method, the gap between the poor and the rich can be minimized (Shigehara, 2015). Minimum Prices The government can balance the economy through the stabilization of the products prices and the incomes of the producers through the effective minimum pricing mechanism. For example the European Union farmers are normally guaranteed of their minimum prices in many products such as wheat, barley and sugar. The prices are set above the free market price in order to stimulate agricultural surpluses (Shigehara, 2015). Renewable Energy Certificates This measure was implemented by the national government in order to motivate the power generating companies to absorb the use of renewable energy resources in the creation of electricity (Shigehara, 2015). Extension of the property rights The government can allocate some property rights to companies in regards to ownership of the resources. The government can infer specific measures pertaining to the use of the resources and the rights people have on them. The government can expand the scope of the property rights in order to cover the natural resources including the mountains, the seas, rivers and also air (Shigehara, 2015). Subsidies The government can have the provision of grants in order to motivate the participants in the production and the consumption of certain goods and services. This offer usually applies to commodities which have a significant external benefit. Examples of such services include education and health (Shigehara, 2015). Buffer Stocks The provision of buffer stocks is normally coordinated by government agencies in order to minimize price fluctuations of a given product and also balance the producers’ incomes. The agency is concerned with setting up a range of the target prices of a given product that is; the maximum and the minimum prices. The government can further control the prices by intervening to ensure the prices remain within the set band in order to prevent changes during variations in demand and supply (Shigehara, 2015). Information Supply The government may compel the producers to provide adequate information pertaining to the products through efficient labeling. The government can also promote public broadcasts in order to improve the knowledge of people through the benefits and the dangers of using particular products for example alcohol and cigarettes. The government can also compel the public companies to be transparent in publishing and auditing of their financial statements (Shigehara, 2015). Conclusion Market failure can lead to undesirable consequences of the economy. The players of the economy can be unfairly placed in the undertaking of their business operations. This situation can lead to demoralization of the players due to unequal allocation of the limited resources. Therefore, the government should intervene in order to promote a balanced and successful economy. References Hetzel, R. L. (2012). The great recession: market failure or policy failure? Cambridge, Cambridge University Press. Great Britain. (2009). Market failure? can the traditional market survive? London, Stationery Office. Bounfour, A., & Miyagawa, T. (2015). Intangibles, Market Failure and Innovation Performance. Cham, Springer International Publishing.  Shigehara, K. (2015). The limits of surveillance and financial market failure: lessons from the Euro-area. Houndmills, Palgrave Macmillan. Read More