This article discuss the issues of market failure. It highlights the main causes of market failure and effective government intervention to correct market failure. It is an important microeconomic policy issue in the current environmental problems on a global scale.
Introduction to market Failure
Definition of market Failure
Market failure exist in a market economy when the competitive outcome of the markets is not efficient from the point of view of the economy as a whole because the benefits to individuals and firms as a result of the workings of the market diverge from the benefits to the economy as whole.
Causes of market failure
Markets fails because the firms and individuals do not have sufficient information to recognize the returns from undertaking an action.
The markets also fails when the private benefit to firms and individuals are not equal to the social benefits of the economic activities undertaken by private firms and the benefits they receive.
In addition, market failure can arise because of monopoly power by some firms dominating the market.
In case of Public goods where the goods cannot be identified with specific individuals or non-exclusive then market will not be able to provide them and it results in market failure such as public amenities to the communities as a whole like public libraries, health services etc.
Market failure also may happen in a market economy due to to immobility of the factors of production due to some reasons. That is if factor mobility do not happen according to market signals then market may not be efficient in allocating scare resources to competing needs as an economy as a whole.
Markets can also fail because it can produce unacceptable income distribution and impose social exclusion there by not producing benefits to society as whole.
Monopoly Power and market failure
Monopoly Power can produce market failure because it produces inefficent allocation of scare resources. It happens because the price under the monopoly is higher than the competitive market price and loss of consumer surplus, output below competitive equilibrium and loss of static efficiency that is allocation efficiency and productive efficiency.
Monopoly also waste resources in excessive advertising for product loyalties and build entry barriers for new entrants.
However monopoly power can bring economic benefits due to economies of sacle producing lower long-run average cost curves and it may use profits to fund research and development and produces more innovation compared to competitive markets and there fore produces dynamic efficiency as an economies a whole.
In addition due to international competition most domestic markets are becoming contestible markets and there fore monopoly power is under pressure and there fore they may bring more benefits than the cost they impose in an economy as whole and over regulation and government intervention for competition may increase market failure under these conditions.