Entrepreneurship & Small Business

Topics: Externality, Market failure, Economics Pages: 6 (2240 words) Published: December 15, 2008
Entrepreneurship & Small Business

Market failure is often given as a justification for Government support of the SME sector. Discuss the various types of market failure, which are said to occur and, drawing on the literature, discuss whether they are valid justification for Government intervention.

The SME sector of an economy is the small to medium sized enterprises, of which is made of 3 different types of enterprise, and they are; micro, small and medium size enterprises. The size of a firm depends upon the number of employees it handles and the industry sector and the market in which a given firm operates. ‘Small enterprises are the backbone of the European Economy’ (Chapter for Small Enterprises, European Council, 2000). They represent in excess of 90% of the worlds gross domestic produce. There are 5 million SME’s in the European Union (Pg. 31,A Guide The Understanding and The Interpretation of Financial Statements, Dr. Clive Vlieland-Boddy, 2008)

Market failure is when the competitive outcome of markets is not efficient from the point of view of the economy as a whole. Market failure may occur when freely functioning markets operating without government intervention fail to deliver an efficient or optimal allocation of resources. A decrease in technical efficiency would also lead to market failure whereby the production of goods and services are not using the minimum amount of resources possible, e.g. burning up finite resources such as oil. Market failure can be caused by both macroeconomic and microeconomic variables. Inflation, interest rates, and economic recession are all macro causes for market failure. These can be said to be more widely influenced by the government. However on the other hand, the Bank of England sets interest rates, of which is now independent from the government. Microeconomic factors for market failure comply with the idea of supply and demand in a specific industry sector. This may be a ‘knock on’ effect of economic recession, such as a decrease in the average household disposable income. Thus meaning that there is a decrease in the demand for luxury or unnecessary goods such as cars. Car sales have greatly decreased globally following the increase in oil prices. The most obvious form of market failure is bankruptcy. In 1986, the UK introduced an Insolvency act, which acted in the favour of most of the starting up enterprises and encouraged more entrepreneurs. Chapter 11 was used as a means of recovering remedies for firms close to bankruptcy. Monopoly is the first type of market failure, whereby a firm can produce a given set of goods or services at a much lower cost than all of its competitors. A natural monopoly results when costs are decreasing in a scale of the firm, which is also called an economy of scale. If it is easy to break into a new market then, the threat of potential competition may be at a disadvantage, as they have no control to the price they are forced to set. Market dominance and abuse of monopoly power would lead to inefficiency in the market due to imperfect competition.

Markets can also fail when the individual or a firm does not have sufficient information to recognise the returns from undertaking an action. Imperfect knowledge can take place by consumers not having adequate technical knowledge, like using the Internet to look at different competitors prices. Advertising can mislead people into interpreting a different message. Producers may also not be aware of all the opportunities, or cannot accurately measure productivity. Decisions are commonly based on past experience rather than future knowledge. ‘The failure of the market to insure against uncertainties has created many social institutions in which the usual assumptions of the market are to some extent contradicted.’ (Kenneth Arrow, 1963)

Externalities may also cause market failure, however they may also be beneficial. These can be categorised by external or social costs (negative...
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