Market failure: A case study - Essay Example

Market failure: A case study Introduction to market failure Market failure refers to the situation where the forces of the free market are incapableof making efficient allocation of resources. This efficiency refers to productive efficiency as well as allocative efficiency (Wilkinson, 2005). This leads to the situation of inefficient market condition. According to the classical school of thoughts, efficient outcome in the market might be achieved at some given conditions of price, cost of production, availability of products and entry barriers. The condition of efficiency is violated if the assumptions related to these factors fail to hold true. When several factors fail within very short period of time, the result is an unstable market condition. Various reasons might lead to the violation of market stability. Some of these are asymmetry in information, imperfect competition or presence of market power with few market players, exchange of imperfect information leading to unreal market expectations and presence of externalities. Such conditions are collectively known as ‘market failure’. There are various studies that look into the ways in which the market failure is corrected. The case of intervention by the government is considered by economist and policy makers for the development of policies to deal with a situation of market failure (Salanié, 2000). However, for understanding the ways to correct market failure, insights into the sources of market failure is required. Some economists generally define the condition of market failure in terms of the public goods or the theory externalities. The way the market is defined explains the source of the market failure. If the market is defined in terms of quality of the environment, then in case of market failure the source of it is traced back to issues in accessibility of public good. Alternatively, if the market is defined in terms of the system of production and consumption that causes some damage to the environment, the source of failure is identified as an externality (Callan and Thomas, 2010). Essentially, market failure is the situation in which there is over supply in the market (misallocation of resources). Since supply is abundant, price received for the good or service is less than the true cost of producing the good (in terms of resources consumed for producing the good) (Dollery and Wallis, 2001). Figure: Market failure (Source: Author’s creation) Role of Competition Commission The Competition Commission of the United Kingdom is “an independent public body” (Competition-Commission, n.d.) which looks after the condition of the market in the country. The Commission ensures that there is a healthy competition among the companies operating in the UK market so that the consumers and the entire economy as a whole ultimately benefits. The body is responsible for conducting investigations on different market activities and for making various other enquiries related to the policies of regulations in different industries in the country. It makes all efforts to preserve the “competition law in the United Kingdom” (Competition-Commission, n.d.). It is a competition regulatory body in the Department for Business, Innovation and Skills (BIS) in the UK. It ensures the establishment of healthy competition among private companies in the UK for ultimately benefitting the consumers as well as the entire economy. The Competition Commission was developed in the 1999 and replaced the Monopolies and Mergers Commission. The activities of the Commission are guided by the policies of the Competition Act 1998 and currently, most of the powers are exercised by the Enterprise Act of 2002. This act has provided the Commission with significant power and it enjoys greater levels of independence than that the Monopolies and Mergers Commission had enjoyed previously. Attempts to correct market failure The power of the Commission is not restricted to offering recommendations to the government. Higher power and greater independence of decision allows the Commission conduct inquiries and make decisions on the basis of the information received from these investigations freely. Additionally, the body also takes appropriate measures and actions (better known as remedies) according to the decisions made. It can take decisions such as an act of intervention in the cases of imperfect market conditions or other criteria related to the extent of market power exercised by different companies operating in the market. The Commission also looks after issues such as financial stability, intervention of media in market phenomena and national security. The aim of the Competition Commission is to promote market competition among the business enterprises in the UK operating within the single market of the European Union. The Commission makes all activities in order to improve individual market performance and make higher contribution towards improved efficiency in the market (Dong, 2012). The policy of competition developed by the Commission aims at establishing wider choice for consumers, helping all enterprises in the market adapt to technological advancement and make innovation (that ensures that only a few firms do not enjoy the advances of technology), introduce effective price competition and ultimately enabling the development and sustenance of dynamic efficiency. As an alternative solution for market failure, competition is a desirable market condition (Wegner, 2008). Under effective competition, the market power of all players is equal and no company enjoys discretionary power in the industry. If the forces of competition are maintained properly it can enable firms to deliver superior quality goods and services at lower prices. Customers also enjoy huge choice since there are several firms in the market offering similar goods at same price. Due to higher efficiency, firms feel strongly incentivized to become more efficient and make investments for innovation thereby raising the productivity growth. Example There is a debate in the telecommunications market regarding the prices charged by the service providers in the Euro zone. The Competition Commission has been involved into this discussion since it is the protector of competitive market conditions in the area. The debate revolves around the prices charged by the service providers when customers of one service provider call others subscribers of the same service provider. Cell C has filed a complaint with the Competition Commission against its market rivals, MTN and Vodacom. These two companies control approximately 90 per cent of the cell phone market share in the Euro zone and the CEO of Cell C, Alan Knott-Craig has accused them of anti-competitive behaviour. However, it leads to a case of market failure. According to the accusation, MTN and Vodacom are offering substantially large discounts on their effective on-net prices while charging premium price from their customers who are making off-net calls. This reflects discriminatory pricing policy. Since these two companies are the dominant operators in the industry, such discriminatory pricing creates anti-competitive power in the market. This is a case of market failure, since customers are being “penalized often without realizing it” (Mochiko, 2013). On-net calls are those calls made by Vodacom subscribers to other Vodacom subscribers and off-net are the calls made between two different subscribers. With the facility of number portability, customers can change their operator or service provider without changing the number. Hence, callers are not always aware which service provider the number belongs to or to which they are making a call. In other words, it often remains unknown to customers whether they are calling on-net or off-net. So they remain unaware of the rate that they are paying for calling a subscriber (Prinsloo, 2013). Investigation by the Competition Commission has raised a debate with regard to the fact that on net calls are priced lower than the off net calls. This indicates that there is improper pricing of the calls. The calls made on net are priced below the actual cost incurred for making call or the price charged for the off net calls which are higher than the actual cost of the call (either of these cases indicate a misallocation of resources). Intervention of the Competition Commission has been desired to investigate into the true situation and take actions to avert further discriminatory activities in the market so as to prevent the market from facing a ‘market failure’. As a consequence of this incidence, the interest of other smaller market players, such as, Bouygues, is hurt. Bouygues and other similar companies are finding it difficult to acquire new customers and are also losing existing customers. It has been indicating that MTN and Vodacom are trying to gain maximum market power in the industry. Discussion Market failure is a situation where resources are inefficiently allocated for productive purposes within the economy. Hence, the market does not achieve dynamic efficiency in the long run. In case of a market failure, the gains accumulated by producers by selling the product in the market is often less than the true cost incurred during the production process. This might also cost the society in terms of environmental degradation. In the example discussed above, decision makers in the Commission must aim at investigating the true cost of the calls and establishing the right pricing policy that should be followed by all market players (OFT, 2009). Establishment of completion would boost up productivity of all firms in the industry, thereby, enhancing overall productivity growth in the telecom industry. The Commission would make such efforts to prevent market failure and benefit the consumers and the society as a whole. Reference List Callan, S. J. and Thomas, J. M., 2010. Environmental economics and management: Theory, policy and applications: theory, policy, and applications. Connecticut: Cengage Learning. Competition-Commission, n.d. About Us. [online] Available at: < http://www.competition-commission.org.uk/about-us > [Accessed 25 October 2013]. Dollery, B. and Wallis, J. L., 2001. The political economy of local government. London: Edward Elgar Publishing. Dong, Y., 2012. Contingent valuation of Yangtze finless porpoises in Poyang Lake, China. Berlin: Springer. OFT, 2009. Government in Markets. [pdf] Crown. Available at: < http://www.oft.gov.uk/shared_oft/business_leaflets/general/OFT1113.pdf > [Accessed 25 October 2013]. Prinsloo, L., 2013. Cell C Fires Next Shot In Price War. [online] Available at: < http://www.bdlive.co.za/business/technology/2013/10/13/cell-c-fires-next-shot-in-price-war > [Accessed 25 October 2013]. Salanié, B., 2000. The microeconomics of market failures. Massachusetts: MIT Press. Wegner, G., 2008. Political failure by agreement: Learning liberalism and the welfare state. London: Edward Elgar Publishing. Wilkinson, N., 2005. Managerial economics: A Problem-solving approach. Cambridge: Cambridge University Press. Read More