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The Sources Of Market Failure Essay

1319 words - 5 pages

The Sources of Market Failure

Market failure is a situation in the free Market system that prevents
the most efficient allocation of economic resources. An optimum
allocation of resources is said to exist when it is impossible to make
on e member of society better off without making at least one member
of society worse off by reallocation the resources to produce a
different range of goods and services. Market failure is a situation
where the free market fails to achieve an optimum allocation of
resources, and this may come about because of (a) market imperfections
(b) externalities and (c) public goods and merit goods.

Market imperfection describes a situation in which the market behavior
differs from what it would be under perfect competition. A monopoly or
an oligopoly may control the market and prevent other firms from
entering the market, restricting supply, the monopoly and oligopoly
firm may be able to fix higher prices than they would be under a free
market. Just as a monopolist may dominate the market, a monopsonist is
a single buyer in the marker. Monopsonists may exert control over the
marker and buy at lower prices from the suppliers. Thus, market power
is a cause of market failure. Another factor accounting for market
imperfection is that households may buy out of ignorance because they
may not have complete and accurate information about all goods and
services that are available. Finally, firms may not be able to respond
as quickly as desired to changes in market conditions. They may not be
able to cut back on production immediately if demand falls, or enter
into a new industry suddenly if demand rises. This slow response of
the price mechanism to changes in demand is an imperfection that
creates inefficiency in the allocation of resources.

Externalities are costs or benefits related to a good or service that
fall on others besides the buyers and sellers of that particular good
or service. They are sometimes called spillovers, neighborhood
effects, external costs or benefits, or external economies of
diseconomies. Thus externalities may be beneficial or detrimental to
the well being of those affected. They are not reflected in free
market prices. Positive externalities are the uncompensated benefits
that are received by individuals who are not directly involved in the
production of consumption of goods. The act of producing or consuming
goods generates benefits to third parties who do not have to pay for
them. Some examples of positive externalities include restored
historic buildings and immunizations. Negative externalities are the
uncompensated costs that are borne by individuals who are not
indirectly involved in the production or consumption of goods. The act
of producing or consuming generates costs to third parties who are not
compensated to suffer or...

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