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Markets - why they fail.

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Introduction

Unit 2: Markets - why they fail * Allocative efficiency occurs when resources are distributed in such a way that no consumers could be made better off without other consumers becoming worse off. * Dynamic efficiency occurs when resources are allocated efficiently over time. * Productive efficiency is achieved when production is achieved at lowest cost. * Technical efficiency is achieved when a given quantity of output is produced with a minimum number of inputs. Consumer and Producer Surplus Types of Market Failure 1. Monopoly Power * A monopoly exists of there is only one firm or supplier in the economy * A firm holds a monopoly share if it holds a market share that exceeds 25%. Why monopoly power market failure exists Firms gain monopoly powers in the long run because of barriers to entry to the industry, preventing other firms entering the industry; 1. Legal Barriers - government can make competition illegal e.g. only pharmacies can sell prescription drugs by law. 2. Resource Barriers - a monopolist may be able to buy or acquire the key resources needed to produce a good. E.g. supermarket may buy the only plot of land available for development of a large supermarket in a small town. ...read more.

Middle

is so great that young people can only afford them if they save for the future, If they don't, they find when they are older that they do not have sufficient resources to pay for medical services, or the insurance to cover them against loss of earnings due to illness or retirement. Conflict of interests - In the case of education the main beneficiary of the consumption of the good (child or student) is unlikely to be the one paying for the good. It could be in the parents interests to pay as little as possible for the childs education but in the childs interest to receive as high a quality of education as possible. Prevention of merit good market failure * Government pays and provides for them * Gives subsidies to encourage production of merit goods by firms * Creates legislature making it compulsory to consume merit goods. Demerit Good - is a good considered socially undesirable and is overprovided by the market mechanism because it is profitable to do so. Consumption of these goods creates a large negative externality. E.g. illegal drugs and legal drugs Prevention of consumption of demerit goods Ban consumption - law states not allow to take hard drugs Price system - tax producers of tobbaco and alcohol thus increasing the price of these goods and reducing demand Advertising - persuade consumers to stop using drugs through advertising campaigns (SMOKING KILLS) ...read more.

Conclusion

Problems with buffer scheme * Administration costs high. * Hard to correctly guess market price. * Scheme may run out of money and be forced to sell excess stock, thus crashing prices in market. Government Failure Inadequate information - bureaucracy Conflicting objectives - every decision made by the government has an opportunity cost e.g. may want to lower taxes but increase public spending. Administrative costs - when the administrative cost is greater than the welfare benefit gained from the correction of the market failure. Market distortions - Intervention to correct one market failure leads to far more serious market failures. E.g Common Agricultural Policy dumping excess supply of food caused by minimum pricing on world market, thus crashing world prices. Therefore farmers outside EU experience lower incomes. Public choice theory - The government may not make decisions to maximise economic welfare but will instead make decisions on spending and taxation that will favour consumers, who are voters. Local interests (Textile plant in constituency, tax on imports) Favouring minorities (middle class voters more likely to vote than working class) Conflicting Personal Interests (corruption) Short-termism (do what is best on the short term but ignore the long term consequences because there is re-election every 5 years) Regulatory Capture - Groups such as monopolies can strongly influence the way they are being regulated to their own advantage ...read more.

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