Factors of Market Failures in Microeconomics - Essay Example

Factors of Market Failures in Microeconomics The term economics stems from the Ancient Greek (oikonomia - management and administration of a household) from (oikos - house) + (nomos - custom or law), meaning the rules of the household. Economics is the social science that examines the production, allocation, and utilization of goods and services. There are two main branches of economics, macroeconomics and microeconomics. While macroeconomics is the study of the national or the regional economy as a whole. Microeconomics is the behavioral study of individual consumers and firms in the market in order understand their decision making process. This is basically the study of interaction between the individual buyers and the sellers and the factors that cause them to make their buying or selling decisions. In an ideal world an equilibrium is achieved in the market, meaning only the amount of goods demanded is being supplied while fully utilizing all the available resources and the whole society benefits. It must be realized that in the real world a "perfect economy" never exists. Recognizing the truth that is not a perfect world, let's examine a few factors which usually end up disturbing the market equilibrium henceforth causing a market failure. A market failure is any condition in which the quantity of goods/services demanded by the consumer is not equal to the quantity supplied by the suppliers. This quantity can be less or more than the market demand. A few such factors which can cause a market failure are agents gaining market power, externalities and sometimes a market failure is caused due to the nature of goods/services or their nature of exchange. These are the main three factors which break the equilibrium and cause a market failure. What does "an agent gaining market power" mean to an individual This term simply refers to the some individuals or firms having certain advantages over the others, which is the basis for the market equilibrium to break and therefore causing a market failure. An agent is an individual or a firm participating in the market directly. Therefore an agent gaining market power refers to the buyer or the seller having certain advantages over others. "That is, some dominant firms may be able to use strategies such as selective price cutting, buyouts, and massive advertising to block entry and competition from even the most innovative new firms and existing rivals. Moreover, rent-seeking dominant firms have been known to persuade government to give them tax breaks, subsidies, and tariff protection that strengthens their market powers" (Brue, McConnell and R.R 256). For instance a firm maybe able to price their goods in such a way so that it is beneficial to them but hurting the competition. From the individuals' point of view, certain groups which require occupational licensing (such as doctors, pilots etc.) are favored. Only the licensed group can obtain high income levels, therefore these groups end up with the advantage of gaining market power, referring to buying power. The basic principle of any perfect society is equality. When a buyer or a seller disturbs the equality principle by gaining market power, this breaks the equilibrium and henceforth causes a market failure. Certain outcomes, such as monopoly, can be very harmful to the consumers. If a firm is able to price their product in a such a way that benefits them, this can literally cause the competition to be driven out of business. Once there is no competition left, the firm is free to overcharge, harming the consumers. This situation can be prevented through government policies and regulations. One such example of prevention is The Competition Act of 1998 in UK, which prevents any anti-competition agreements between businesses. An other factors that can contribute to a market failure are externalities. An externality of an economic transaction is an impact on a participant that is not directly engaged in the transaction. In such circumstances, costs do not reflect the full value or gains in production or consumption of a product or service. A positive impact is called an external benefit, while a negative impact is called an external cost. Producers and consumers in a market may either not endure all of the costs or not obtain all of the benefits of the economic activity. For example, manufacturing that causes air pollution inflicts costs on the entire society, while reducing the pollution or helping clean it improves the safety of the community and the environment causing a positive externality. "This will have grave consequences, not just on the community but eventually on the whole economy." Sara warned Mr. Thomas who wouldn't stop polluting the local lake. The waste material from his fish factory was directly being thrown in the lake. He wondered how could his actions have any affect on the economy at all. Any actions undertaken by an individual does always has effects on the economy, directly or indirectly. "One possible cause of market failure is an externality, which is the uncompensated impact of one person's actions on the well-being of a bystander. For instance, the classic example of an external cost is pollution" (Mankiw and Taylor 11). Mr. Thomas was causing a market failure through external cost factor, polluting the lake. If Mr. Thomas was not polluting the lake or atleast taking care of it by paying the sanitary services, this would cause him to only produce the optimal minimal fish needed to achieve the market equilibrium. However now since he is saving money by simply polluting the lake, he can afford to produce more fish, even though that is more than what is demanded in the market. Breaking the equilibrium of the market, causing a market failure. Plus the cost of the pollution is being paid by the society. The bystanders are having adverse effects. They are unable to go swimming in the lake. This is a prime example of a negative externality. In such cases the government can and does intervene and may put a tax on this pollution or make clean up mandatory. Some economists even believe that the government should charge a fee for the right to pollute, which would internalize the external costs and create a disincentive for polluting. Such actions from the government can prevent a negative externality. One more factor that can cause a market failure is the nature of the goods/services or the nature of their exchange. How can a nature of the good or the nature of its exchange cause a market failure It is possible that the nature of the good really prevents it from being profitable to the economy. For instance, a street lamp is a good that everyone will utilize, however no one individual who uses this product will pay for it. Therefore if a product is being used without the cost being provided to the supplier than a "free-riders" problem arises which in turn causes a market failure. "To create a market it must be possible to exclude the nonpayer from consuming the good. Otherwise the rational, self interested individual (economic man) will choose to be a "free rider" and not pay. Thus nonexcludability, the inability to exclude the nonpayer from consuming the good or service, is one defining characteristic of a public good" (Levy 83). There is one main factor to be considered, a market cannot provide a free service or good to anyone. Some products, such as street lamps, are nonexcludable, implying that no one can stop an individual from using a street lamp. Additionally this product is non-diminishable, indicating that no matter how many individuals utilize this, it will still remain the same. This causes the market's inability to exclude an individual, who is not paying for a good or service, to be excluded from participating in the market. In turn again disturbing the equilibrium and causing a market failure. However, just as before, this condition can also be prevented through government intervention. The government can intervene and pay for this good/service from the tax payers dollars. There is always a solution. All of the above mentioned factors are harmful the health of a perfect economy. One thing to always remember is that the economy is the study of real people's buying and selling behavior. The keyword is real people. Real people will never have anything perfect. Self interest will always be the deciding factor in all decisions made in the market. Which leads to either three of the factors causing market failure. Nonetheless in some manner or way all factors occur at all time, even though it may not be recognizable at a first glance. Likewise all of them can be atleast limited by government intervention. Although many economists do not like government interventions and believe in a government free economy. Although the truth is that government intervention actually facilitates the economy through various techniques. Market failure causing factors will always remain and but can be prevented through proper aid. Our policy makes must be willing to only intervene at the proper times when it is most required. Otherwise over intervention can also be harmful to the economy. The government must identify how and when to interfere, and for all this the study of economics must be accomplished precisely and truthfully through magnifying glass. Which is in turn the study of individual behavior in a market, microeconomics. OUTLINE An Analysis of Market Failures in Microeconomics I. Introduction to Microeconomics A. What is a Market Failure B. Causes of Market Failure 1. Agent gaining market power 2. Agents' action causing externalities 3. Market Failure due to nature of goods, or nature of their exchange II. Agent gaining market power A. What does this mean B. How an agent can gain market power C. The relationship between the market failure and agent gaining market power D. The outcomes E. Can this be prevented III. Agents' action causing externalities A. What are externalities B. What actions can cause externalities C. The relationship between market failures and externalities D. The outcomes E. Can this be prevented IV. Market Failure due to nature of goods, or nature of their exchange A. Which goods or their exchange can cause this B. What kinds of goods can cause a market failure C. The relationship between market failure and the nature of goods and their exchange D. The outcomes E. Can this be prevented V. Conclusion A. Which occurs the most B. Which is the most harmful C. Can any of them be prevented D. My opinion E. How all this is inter-related Bibliography 1. Stanley L. Brue, Campbell R. McConnell, and Campbell R. R. _Microeconomics: principles, problems, and policies_. Edition: 16. N.p.: McGraw-Hill Professional, 2004 2. Mankiw, N. Gregory and Taylor, Mark P. _Microeconomics_. Edition: reprint. N.p.: Cengage Learning EMEA, 2006. 3. Levy, John M. _Essential microeconomics for public policy analysis_. Edition: illustrated. N.p.: Greenwood Publishing Group, 1995. Read More