Market Failure - Case Study Example

Case Study: Market Failure It is apparent that market failure is a term that has gained a lot of popularity not only among the economists but also to other people for instance the learners as well as institutions. Evidently, where market failure is common economic case for government intervention is very clear. Market failure is a term used to describe the situation in economic theory whereby the provision of services as well as goods or products by a free market is not proficient (Books, 2010). This is to mean that another outcome within the market whereby someone especially the participant will benefit and not at the cost of another participant (Books, 2010). Studies indicate that market failures could be viewed as cases in which a person’s desire for personal gain results to inefficiency (Books, 2010). The term market failure has its roots back to the times of the Victorian philosopher by the name, Henry Sedgwick. Evidently, market failures are in most cases associated with non- competitive markets, public goods, information asymmetries, externalities as well as principal agent problems (Books, 2010). Apparently, the presence of a market failure is linked to the intervention of the government to a particular market. According to economists, particularly the micro economists, of a major concern are the cause of the market failures and ways of solving the failures in case of occurrence (Books, 2010). This kind of analysis of paramount to a number of public policy decisions as well as decisions. As evidenced by past research, some policy interventions by the government for instance bailouts, taxes, price control, wages, regulations, subsidies as well as the attempts to address market failures certainly lead to an inefficient resource allocation (Mankiw, 2011). This is at times called government failures. Therefore during some instances there exists a choice between the imperfect outcomes with the government interventions and without the government interventions (Mankiw, 2011). The normal operations of the market forces that result to economic inefficiency are due to a number of reasons Types of market failures Monopoly power In the contemporary world, it is evident that only a few markets are able to meet the requirements deemed right for a perfectly competitive market (Mankiw, 2011). Markets may not be in a position to control the abuses of monopoly power as monopoly power creates the possibility for a market failure (Mankiw, 2011). According to studies, monopoly power is quite widespread and it exists even in areas with many suppliers. For instance in markets with two firms, duopoly as well as a few firms, oligopoly (Mankiw, 2011). In this kind of market the price is higher while the output is low. Missing markets Markets could fail to form as a result of their failure to meet a want or a need for instance need for public goods for example street lighting (Mankiw, 2011). According to studies markets can only be formed under certain conditions. Whenever these conditions go missing, it becomes a struggle for a market to exist. For instance, when a firm releases chemicals that pollute the river when operating, and ignores the external cost, the one who suffers is the fisherman who loses revenue due to the fact that the fish will die (Mankiw, 2011) Incomplete markets In some instances, a market may fail to deliver sufficient merit goods (Mankiw, 2011). Incomplete market is a situation where not all the required conditions for the formation of a market exist. In such a case the market supply is inadequate and hence the market fails to develop entirely (Mankiw, 2011). This can be evidenced by a situation whereby a firm lacks the securities for trade and therefore it is unable to trade to prevent bad realization of nature hence remain exposed to potential undesirable outcomes. Case study: Water scarcity in China’s current market According to a special report by a global economist, china is experiencing water scarcity thanks to the rapid agricultural and industrial use (Xie, 2009). Of the total global average of water, the only water available for use to every head of population is only a quarter. In addition the ground water is being used at a rate faster than it can replenish. The report indicated that even the sewages in Beijing are not all treated (Xie, 2009). Moreover, the rest of the cities in China treat none of their sewages (Xie, 2009). According to the officials of China, approximately 160000 square kilometers of the ocean shores of China have been contaminated by effluent from the polluted rivers. The World Bank on the other hand reports that more than half the waters of the biggest river basins in china are unfit for human consumption (Xie, 2009). Due to these problems, the health problems have escalated and as a result the rural output has reduced by about 2 per cent. Furthermore, the costs to agriculture and industry of scarce as well as dirty water sap the gross domestic product by some percentage. The figure below seeks to show that increased pollution and water scarcity are direct externalities of industrialization and urbanization. The problem can be viewed both as a market failure and also as a incomplete market in the sense that water is a public utility for the masses and at the same time a commodity for industries. Urbanization in modern societies is viewed as an indicator of economic development. In China, rural urban migration has been rampant in the recent past leading to straining of water resources in urban centers. The water and sewerage infrastructure have not been developed to meet growing demand and as such there is a shortage. The result is that rivers and ground water is overexploited leading to drying up of rivers used for irrigation by rural farmers. Poor sewerage systems lead to contamination of oceans and rivers harming fishing and farming and tourism. This can be said to be a negative consumption externality because the urbanization as a benefit to the country is negatively affecting farmers, fishermen and tour operators. From the figure above, take local authorities (urban centers) as being social benefit production unit with the marginal revenue curve AB. The urban centers marginal cost curve is shown by OC which rise as output rises. Profit maximization occurs at Q1 where MR=MC. However, marginal social cost exceeds marginal private cost because of the externality imposed on farmers, tour operators and fishermen. The marginal social cost is shown by the curve OD which is sloping upwards assuming that increased urbanization leads to increased water shortage and pollution. The socially optimum level of urbanization is where MR=MSC at Q*. However, this is below the profit maximizing urbanization level of Q1. The actual dead weight loss is indicated by the triangle EGH. Besides, global warming is also a contributor to the water scarcity in China (Xie, 2009). As indicated by the Intergovernmental Panel report on climate change, the Himalayan glaciers that are known to feed the biggest rivers of China are melting. The report further indicated that if the situation was not resolved, there is a high possibility that the glaciers will disappear by the year 2035 or even sooner. According to Xie (2009), as a result of this disappearance of the glaciers, China’s farmers will be on the losing end. The part to be affected most will be the Northern China which had apparently lost approximately 36, 000 square kilometers as a result of desertification. The Intergovernmental Panel on Climate Change further indicates the water supply would fall 30 per cent below what is expected (Xie, 2009). Besides, the rising sea levels and increased sea waters are suspected to reduce the available water for arable land and this could result to food insecurity in China. Evidently, the water table in some places for instance Beihuadan, a village in Hebei province, a few kilometers from Beijing is rapidly falling (Xie, 2009). According to the report, there have not been any waters at the river of Beijuma that runs at the edge of Beihuadan village (Xie, 2009). Mankiw (2011) indicates that such environmental problems arising from externalities and public goods really arise because markets are missing and not because markets produce 'undesirable' results. This implies that solutions must aim at completing the incomplete market and creating the missing ones. How the government has addressed the presence of negative externalities in the market To address this situation, the government of China aims at investing in a system of pipelines, canals, as well as aqueducts to help divert the water from soggy south to the North (Xie, 2009). In addition, the government is trying to encourage a sparingly use of the available resource as well the practice of efficient and sustainable practices in the use of the resources (Xie, 2009). At the same time fine imposed on the industries releasing effluent to water bodies to reduce the water pollution has been tripled to ensure the industries are more conscious of their waste water (Xie, 2009). In addition, a French conglomerate, Veolia, has been hired by the government to develop as well as operate model treatment plants for waste water across several big cities in China to reduce the rate of water pollution in the rivers and water basins (Xie, 2009). Besides, the government has also asked the help of the World Bank in addressing the current water scarcity (Xie, 2009). The World Bank agreed to assist and they launched an analytical and advisory assistance commonly known as the AAA program (Xie, 2009). The main objective of the program was to help the government of China to create, adopt as well as implement an incorporatedset of institutional reforms deemed effective to solve the issue of water scarcity (Xie, 2009). The program in particular will focus on improving the understanding the major water related policy as well as institutional issues so as to recommend the right reforms to address the issue (Xie, 2009). Moreover they will enhance an enabling environment for the suggested actions by ensuring that the inter-jurisdictional and cross sector differences are reduced (Xie, 2009). In addition, they will ensure that there is cooperation at the ground level. In conclusion they will engage the government in creating awareness on the management of integrated water resources (Xie, 2009). Other options for dealing with negative externalities in your case studies In order to address the externality of water scarcity, it is recommended that actions are applied at the local, national as well as the river basin levels (Pereira et al., 2009). In addition, it also necessitates actions at both the global as well as the international level. This requires an increase in collaboration between the various nations on a shared management of the scarce resources for instance the rivers, aquifers and lakes (Pereira et al., 2009). Furthermore, an interdisciplinary approach towards managing the water resources is required. This is so as to maximize the social as well as economic welfare in a manner that is equitable and that will not compromise the sustainability of the vital ecosystems (Pereira et al., 2009). In addition in order to address the issue of water scarcity integration between the sectors is of great importance (Pereira et al., 2009). The integration should take into consideration the supply, development, demand and use (Pereira et al., 2009). Besides, it should place more emphasis on people, their way of living as well as the surrounding ecosystems that support their existence. So as to address demand, water productivity should be enhanced (Pereira et al, 2009). This means that water volume production per unit is increased as this will help make the programs for the water scarcity alleviation successful. Moreover, the natural ecosystems that capture, filter, release, and store water for instance the rivers, forests, wetlands and soils should be well protected as well as restored in case of damage so as to enhance the availability of quantity as well as quality water for consumption and irrigation (Pereira et al., 2009). This should be done through imposing taxes on those who destroy the natural ecosystems such as cutting down trees and practicing deforestation (Pereira et al., 2009). In addition, a campaign to create the awareness of the problem of water scarcity should be carried out both at the local and the national level. The community should also be encouraged to engage in water harvesting techniques so as to ensure that there is surplus water for uses in case of a dry spell (Pereira et al., 2009). Moreover, the government should ensure that they integrate rain water fully in their management strategies in order to address the issue of water scarcity entirely. In some cases water scarcity is as a result of poverty (Pereira et al., 2009). It is apparent that while the rich enjoys the access to clean water due to the fact that they can easily afford, one in every five persons in the developing world lack the access to the clean water since they cannot afford and that they are charge more than the developed populations who have an access to the piped water (Pereira et al., 2009). Due to these reasons, measures should be put in place to ensure that everyone is entitled to a fair as well as a safe access to sufficient clean water that is of great importance to the secure their livelihoods and sustain their lives (Pereira et al., 2009). This therefore necessitates that there is a transparency and equity in the institutions providing the water services. In conclusion the government should ensure that there are set policies governing the use of water. In addition it should see to it that the set as well as regulations governing the water bodies and usage of water are enacted according to the requirement of the law. To ascertain that the law is effectively implemented, they should impose a rule to punish those who do not conform to the law. References Books, LLC, 2010. Market Failure: Externality, Natural Monopoly, Environmental Economics, Tragedy of the Commons, Government-Granted Monopoly. Oxford: General books, LLC Mankiw, N.G., 2011. Principles of Economics, 6th ed. London: Cengage Learning Pereira, L.S., Cordery, I. and Iacovides, I., 2009. Coping with Water Scarcity: Addressing the Challenges. New York: Springer Xie, J., 2009. Addressing China's water scarcity: recommendations for selected water resource management issues. London: World Bank Publications. Read More