Market Failure - How Do Markets Fail and What Can Be Done About It?
Jordan Alexander February 14, 2012
Economics Essay – Market Failure
1. Markets fail when they under or over allocate resources of production or consumption, relative to the best interests of society. Market failure occurs due to four main factors: the existence of externalities, asymmetric information, the abuse of monopoly power, and inequalities and wealth and development. The existence of externalities means that the market mechanism does not always work efficiently. Markets run on a mechanism that only takes into account the private benefit and cost for a good. Besides the marginal private cost and marginal private benefit, there are the marginal social cost and marginal social benefit, which are external. As a result, governments must find responses to try to solve these market failures.
2. Externalities are the effects of market activities on other people that are external to the market. They are either positive externalities or negative externalities. When the social benefit of a good equates the social cost, it is known as the social optimum. Goods that have large positive externalities can either be public goods or merit goods. Public goods are non-rivalrous and non-excludable, while private goods, such as a merit good, are rivalrous and excludable. When a good has large positive externalities, the government should support its production. When a good has large negative externalities (demerit good), the government should limit or stop its production and consumption. Markets can fail in regard to externalities in four ways: lack of public goods, under provision of merit goods, over provision of demerit goods, and environmental degradation.
Graph 1 demonstrating MPB and MPC to the individuals participating in the market.
Graph 2 demonstrating positive externalities, when the social benefit is added to the private benefits. This means that total demand for the product will be greater, because society will be willing to pay a higher price,
Economics Essay – Market Failure
1. Markets fail when they under or over allocate resources of production or consumption, relative to the best interests of society. Market failure occurs due to four main factors: the existence of externalities, asymmetric information, the abuse of monopoly power, and inequalities and wealth and development. The existence of externalities means that the market mechanism does not always work efficiently. Markets run on a mechanism that only takes into account the private benefit and cost for a good. Besides the marginal private cost and marginal private benefit, there are the marginal social cost and marginal social benefit, which are external. As a result, governments must find responses to try to solve these market failures.
2. Externalities are the effects of market activities on other people that are external to the market. They are either positive externalities or negative externalities. When the social benefit of a good equates the social cost, it is known as the social optimum. Goods that have large positive externalities can either be public goods or merit goods. Public goods are non-rivalrous and non-excludable, while private goods, such as a merit good, are rivalrous and excludable. When a good has large positive externalities, the government should support its production. When a good has large negative externalities (demerit good), the government should limit or stop its production and consumption. Markets can fail in regard to externalities in four ways: lack of public goods, under provision of merit goods, over provision of demerit goods, and environmental degradation.
Graph 1 demonstrating MPB and MPC to the individuals participating in the market.
Graph 2 demonstrating positive externalities, when the social benefit is added to the private benefits. This means that total demand for the product will be greater, because society will be willing to pay a higher price,