Market Failure

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Market Failure
"As long as producers and consumers act as perfect competitors, that is, take prices as given, then under certain conditions, a Pareto efficient allocation of resources emerges" - Fundamental Theorem of Welfare Economics Pareto Efficient Allocation is a point of efficiency, wherein the only way to make one agent better off is to make others worse off Governments have two reasons for their activity - Tax Collection and Public Expenditure - Regulate Market Failures Market Failure - Is an economic situation where resources are misallocated - May be caused by two possible factors: ○ Market Power ○ Non-existence of Markets Why is Market Power a source of Failure? - Marginal Cost Pricing is not practised (P > MC) - There is a tendency for firms to behave according to profit-maximization motive because they have market power. - This type of market failure is borne from Imperfect Competition Non-Existence of Markets - The non-existence of a market would mean that we can hardly expect the resource to be allocated efficiently. - Many forms of market failure are borne from this: ○ Information Asymmetry ○ Externalities ○ Public Goods Conditions of Market Failures 1. Imperfect Competition - Monopoly, Oligopoly and Monopolistic Competition entail P > MC - This would result to consumers paying more than the true cost of production and that they consume less, thus leading to this being an inefficiency - Economic Rent/Rent-Seeking Activities - premium paid by monopolies to governments to protect monopoly position. Economic Rent is defined as the difference in price when P > MC and P = MC - How do we regulate Monopolies? Price Controls, Lump Sum taxes, Excise and Specific Taxes  Taxes (particularly excise) , however, has its own distorting effects on the economy, as it raises prices and decreases quantities 2. Public Goods - A good exhibiting the characteristics:  Non-rival in consumption - the consumption of one does not deprive others of the good ...