Microeconomics-Market Failure

Example of market failure and possible solutions

Aviation and market failure

The main external cost of aviation is the damage it causes to the environment. For example it is estimated that one return flight to Florida produces as much carbon dioxide as years of motoring. In addition the gases produced by aviation in the stratosphere produces much effect than if produced on ground. In addition as air travel is growing faster due to technological advances and low cost airlines operations and greater business travel by aviation the pollution it causes increase as a percentage of all pollution sources and may become a significant polluting economic activity in the future. As well, the use of old planes by former USSR also causes more pollution in the future. There fore aviation produces significant market failure as the social cost and private cost diverge.

Possible Government policies to correct aviation market failure

Tax on fuel is one of the method to corect aviation market failure. However it has serious draw backs compared to the benefits it gives to correct market failure. For example as the aviation market is price inelastic tax on fuel may not adequately reduce air travel and it is a costly measure. In addition it has equity issues because it will hurt low cost airlines and reduce the low-income people to travel. There fore tax on fuel in an ineffective way to correct the aviation market failure.

The alternatives are giving subsidies for greener airlines, Subsidies to research and develop greener air fuels, Advertising cleaner transport modes such as trains and other public transport, donation by consumers to forestry schemes to leave a neutral carbon foot print, a market based solution by introducing Carbon Emission Trading Scheme. Do noting and market find a solution without explicit government intervention to correct the market failure. All these alternatives has benefits and costs. However, a mix of polices can be more effective than one policy.

In the context of aviation market failure is not an option because the free market will not adequately solve this problem. There fore some government intervention is necessary. In evaluating the benefits and cost of the alternatives to tax on fuel the best cost effective government intervention is to encourage other modes of public transport for short-haul flights and investment in those transport modes. For long-haul air transport this may not be effective. However a carbon emission trading is the best option for long-haul flights to correct aviation market failure. In addition, the consumer donation to forestry industry because it is least costly event though it may not be adequate in finance terms as a secondary option.

Conclusion

As discussed above, market failure occurs due to may causes in an advanced market economy. The main causes are externalization, information inadequacy, factor immobility, monopoly practices in the market, public goods under consumption of merit goods and over consumption of goods which has higher social benefit than private benefit. In addition market failure also occurs due to the fact it some times produces unacceptable income inequalities and poverty and social exclusion. When ther is market failure free market may not solve these problems adequately, However, market based incentives and market solution with non-market solution by government may correct market failure. That is, government intervention to some degree is important in correcting market failure. It is also important that inappropriate market intervention based on subjective value judgments may produce more problems than it solves. In other words the cost effective government intervention evaluated objectively is mostly will correct market failure effectively than leaving the free market to correct market failure in most situations.