What Is Meant by Market Failure and How Can the Government Attempt to Correct It?

Topics: Market failure, Externality, Public good Pages: 6 (1941 words) Published: May 14, 2013
Global Business Environment
Assignment 1
What is meant by market failure and how can the government attempt to correct it?

Why do some markets fail? Market failure is said to occur when the price mechanism is unable to allocate resources efficiently. Meaning that the forces of supply and demand lead to a net welfare loss in society, that the resources were not used to their maximum capacity. When there is market failure it is down to the government to correct them. Here are five way in which the market can fail • Externalities

• Asymmetric information
• Monopoly market
• Public Goods
• Factor immobility


“The social optimum output or level of consumption diverges from the private optimum.” (tutor2u,n/a,n/a)

Externalities are external cost and external benefits which occur due to economic activity. However externalities do not involve the buyer or the seller in the purchase of a good or service, as they are only concerned about their private wants. But the effects are felt by the third party, these can be split into two sections. Positive and negative externalities.

Positive externalities:

This is when all the benefits of a good or service are not appreciate. Education is one example of a positive externality, when one person is educated they then have the knowledge to educate others, creating a positive knock on effect. However these benefits are not realised by society and therefore they are under produced.

Negative externalities:

This is when producers or consumer cannot be charged with all the cost. For example air pollution. The producer emits gases fumes from the factory, which cause acid rain and harm to the environment. Consumers smoke cigarettes affecting other people healthy. These are external cost which affect the third party. However they are in high demand and producers manufacture more of the good than is socially beneficial.

However the government attempts to correct this by one, giving subsidies to goods that yield external benefits. This is a grant provided by the government, to increase the level of production in certain industries, in this case it would be education, higher education, farming, and health care, in order to stop the industry from collapsing or to help make society more aware of the good or service. The second attempt for the government is tradable pollution permits. This is when the government cap the amount to pollution emitted by companies, however firms can buy other firms permits to increase their limit.

Asymmetric information

This is a situation where by a consumer or a seller has more information on the product than the other, where by there is imperfect knowledge in the market and therefore a miss allocation of resources. A perfect example is the selling of a car. The owner has full knowledge of the car, about the history, if it’s unreliable, where the seller uses their superior knowledge over the customer. The consumer on the other hand is completely in the dark, and doesn’t know much about the car. Vice versa if the consumer was buying an antique and the seller didn’t know. The consumer can then exploit their asymmetric information and buy it cheap. However it is most common for experts such a doctors, dentists and mechanics to exploit asymmetric information.

Governments attempt to correct this by enforcing laws where by the firm or an individual cannot exploit their position and them must show documentation on why the procedure needs to be done.

Monopoly market

“A monopoly is simply a market with only one seller and no close substitutes for that seller's product. Technically, the term "monopoly" is supposed to refer to the market itself, but it's become common for the single seller in the market to also be referred to as a monopoly (rather than as having a monopoly on a market). It's also fairly common for the single seller in a market to be referred to as a monopolist.”( Jodi Beggs,...
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