Market Failure and Government Attempt to Correct It - Coursework Example

Market Failure and Government attempt to correct it Contents Introduction 3 Discussion 3 Market failure 3 Common property 4 Externalities 4 Monopoly power 5 Information failure 5 Inequality 6 Lack of markets 6 Government attempts to correct it 6 Government legislation and regulation 7 Fiscal policy intervention 7 Intervention to close the information gap 8 Effect of government intervention 9 Conclusion 9 References 11 Introduction The market failure is defines as a situation in which the allocation of the goods by the market is not efficient. The existence of market failure means that there can be another situation where the allocation of resources can be done more efficiently. The market failure is actually a result of the scenarios in which individuals’ performance of self interest leads to markets that are not efficient. Market failures are associated with different practices that are the characteristics of market failure such as information asymmetry, principal agent relationship etc. Market failures are the reason why governments have to intervene sometimes in order to regulate the market and bring in efficiency. But many a times it happens that the government intervention actually aggravates the problem and creates something that is called government failure. So the market failure is a dual edged sword. On the one hand is the costs that is caused to the society by the market failure and on other hand the probability that the government intervention to bring back the state of market equilibrium may result in greater inefficiency. The subject is analyzed in the following pages by looking at the subject from two view points. In the first part of this essay what is market failure is being tried to be defined and in the second half of the essay the government attempts that are designed to correct the market failure are stated. Discussion Market failure Market failure is something that is inherent in the market and is responsible for the inefficient allocation in the equilibrium. A theorem in welfare economics tells that in the long run perspective the market equilibrium in terms of allocation of resources is always efficient. This result is fantastic as because it says that in essence no matter how selfish individuals work and look upon their best always results in efficient allocation of resources in the long run. However whenever the theory is presented the presenter often ignores the fact that this hold true only for certain specific condition. Markets in equilibrium however do not always achieve efficiency. If the market is unregulated then the allocation in equilibrium is inefficient and the market is said to fail. This is the case of market failure. In the cases of resources and environmental sectors of the economy the evidence of market failures is enormous. In case of the allocation of many environmental and natural resources the market fails and thus it results in the inefficiency of the entire market. There are different categories of market efficiency. The most common categories of market efficiency are: Common property Common property are the resources to which access are not controlled. A resource is common property if the resource is not owned effectively by any one. While there are few resources that are purely common property resources natural resources commonly fall in this category as access to the resources is uncontrolled or if they are controlled only to a some extent (Munday, 2000). The common property fishery causes the market to failure; similarly a common property oil field will cause the market to fail. Since the availability of animal was a common property so indifferent hunting has led to many animals going on the verge of extinction. Externalities Externalities are the factors and are not parties to the transaction but are affected due to the transaction. The business in between two parties may have an effect on a third party who may not be a part of the transaction that goes on in between the original parties that were part of the business (Library of economics, 2012). Externalities may be of two types positive and negative. Positive externalities- Positive externalities are the parties that are positively affected by the transactions that have taken place between two different parties. For example if a person drives a bicycle then he causes less environment pollution and people in general are benefited. Negative externalities- This is the important and deciding factor in market failure and refers to the in-equilibrium and inefficiency that is caused by certain class of consumers who pursue their own self interest. Monopoly power In markets where the few suppliers or businesses control the maximum of market then a monopoly is formed. In case of a monopoly the market forces are unable to control the market and the abuses of power by the monopoly forces (Economics online, 2015). The control of the market by the monopoly forces causes the market to become inefficient. A monopoly business makes excess profits by producing in less quantity. Since the monopolist is the sole producer of the commodity it can deliberately produce the items in lesser quantity so that the item becomes scarce and increased demand for the scarce item increases the price of the commodity. In many items like scarce natural resources monopolistic trade practices still exists. Although monopolistic trade practices are an important cause behind market failure; this practice is good from the conservation point of view. If the scarce natural resources would have been controlled by competitive forces then it would result in more resources being extracted every year under pressure of competition and lead to the first depletion of these resources. Information failure Information failure or information asymmetry may make the market inefficient. Information asymmetry may result in situation when more information is deliberately available to certain specific entities than to the market in general. The selected individuals’ make use of the greater amount of information that is available to them for their own benefits. This may cause the market to fail. Inequality Market may also fail due to the income gap that exists in the society. If the size of the gap increases then this may lead to failure. Market transactions that occur are used to reward consumers and producers with high levels of income and profits. However the majority of these rewards may be concentrated in the hands of the few and the society in general may not be able to get the benefits of these rewards thus leading to market failure. Lack of markets For certain commodities for which markets do not exist, the market forces cannot allocate the resources efficiently. The examples of commodities for which a proper market is not available is air, water etc (Morey, 2014.). In the case of these types of commodities market failure may be the result. Government attempts to correct it The government may choose to intervene in the market so as to efficiently allocate the resources and achieve that what the government thinks as the will lead to the improvement of the general economic and social condition. There are many reasons behind a government trying to intervene in the market: 1. To correct for market failure 2. To achieve an equal distribution of wealth and income amongst all sections of the society. 3. So that the economy may perform well. There are many ways in which government may intervene in the market. Some of the mechanisms that the government uses to intervene in the market are Government legislation and regulation Government can enact legislation sometimes to control the sale of certain goods or impose a prohibition on the sales. Government enacts certain competition policy act against fixing of prices by cartels or monopoly or other forms of behaviour that are anti competitive. Government may also introduce employment laws that are used to fix minimum wages that must be paid to the employees of the company (Winston, 2007). Government may impose huge and growing amount of regulation so as to impose price control on the economy. In order to reduce the market inefficiency and market in-equilibrium and to increase the competition in the market is through market liberalization. Fiscal policy intervention Fiscal policy is used to alter the level and pattern of demand within the economy. Some of the fiscal policy measures that are used to distribute the goods and services uniformly and to prevent market failure are: Indirect taxes: Indirect taxes are used to raise the prices of goods which have negative externalities. This is done so as to limit the cost of these goods so that the demand of these good reduces amongst the consumers. Subsidies: Subsidies are used by the government as a measure to reduce the prices of goods that have positive externalities. This is done so that the consumption of these goods may increase amongst the consumers. A subsidy causes an increase in the market price of the good and leads to equilibrium prices. Tax relief: Government may sometimes provide tax relief to the corporate which invest in research and development activities. Tax relief may also be provided to the new business ventures so as to facilitate investments in the market. This may be used as a way to attract new investments so as to break away from monopoly trade practices which causes the market to fail. Changes to tax rate and welfare payments: these schemes are used by the government to affect the overall distribution of the income and wealth in the society. These schemes are used by the government to reduce the income inequality that exists in the society so that the market is not prone to failure. Intervention to close the information gap Often market failure is the result of information asymmetry. Market failure is a result of the information not being available in the market about the cost and benefits of a product. Government may intervene to cause the information about cost and benefits being widely available in the market among different groups of consumers. Some of the ways that the government may intervene to cause that information may be uniformly available about the product throughout the society is through the following measures. 1. Compulsory levelling of the harm that may be caused by using certain products on the product level of the different category of products 2. Nutritional information of different categories of food products should be included in the packet of the product The strategy of the government in making the display of this information compulsory is to ensure that all the classes of the society get all the information required so that there is no information asymmetry. Effect of government intervention The effect of different forms of government intervention in the market is never neutral and the financial support given by the government to one class of the society creates the winners and losers in the society. It is important to judge a government policy based on different criterion. The following criterions are used to judge the government policies: Efficiency of the policy: Does a particular intervention lead to better use of the scarce resources in other words do the government intervention leads to reduction of the lessening of the market failure. Effectiveness of the policy: What are the government policies that are used to rectify the particular economic condition that is hampering efficient transformation of the economy? Conclusion After the analysis of the market and the forces that are the cause of the market failure throughout the course of the paper the various factors that have been identified as the reason behind market failure are common property, externalities, monopoly power, information failure, inequality, and lack of markets. The externalities are the third party agents who are affected by the transactions that are cause in between two parties of the business. Common property refers to those resources to which access are not controlled, since this resources are not controlled they can be utilized for selfish motives by the individuals and this may result in market failure. Monopoly power refers to those businesses which control and dominate the market. Monopoly power reduces the market availability of goods of certain specific commodities that causes the prices of the goods of the commodity rise phenomenally and so that they can earn good amount of profit. Information failure may also result in market failure by causing information to be available to only certain groups who can use that information to their benefits. Another cause of the market failure is the inequality or income gap that exists in the society. Government may take certain measures to control market failure such as implementing new legislation, fiscal policy intervention etc. However the matter of government intervention is a delicate one and should be considered carefully otherwise it may cause a bigger failure. References Economics Online, 2015. Types of market failure. [Online] Available at [Accessed 6 March 2015] Library of Economics, 2012. Market failure public goods and externalities. [Online] Available at [Accessed 6 March 2015] Morey, E., 2014. An introduction to market failure. [Online]. Available at < http://www.colorado.edu/economics/morey/4545/introductory/marketfailures.pdf> [Accessed 6 March 2015] Munday, S. C. R., 2000. Markets and market failure. Oxford: Heinemann. Winston, C., 2007. Government failure versus market failure: microeconomics policy research and government performance. Washington D.C.: Brookings Institution Press. Read More