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Explain how market failures can occur

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Market Failures Stephanie Merks a.) Explain how market failures can occur b.) What policies can governments use to correct market failures? A Market Failure is a situation in which uncontrolled market forces lead to an under allocation or over allocation of resources to a specific activity. When these failures occur the government intervenes and puts up policies to try to eliminate the problem. The governments has many general economic goals that they want to achieve so that their economy is in good health. Some of the main goals include low unemployment, low inflation, a balance of payments, economic growth and a fair distribution of income and wealth. These are all to satisfy the people of their respective countries. Unfortunately for them, this cannot all be true because of many internal and external market pressures out their control. This is why markets experience booms and slumps, where the business cycle goes through recessions and recoveries. During a boom, increases occur to put a market closer to some of its goals. Although, some problems can occur for the increase in inflation and imports, which disturb the balance of payments and therefore may help bring the market into what is known as a slump. ...read more.


When there is no free market mechanism, for instance when one company monopolises a certain supply or manufacturer of goods, prices can spin upwards out of control. The lack of competition allows these companies to set their prices at virtually any level without losing demand for their products. In an ogliopolistic market the main producers can come together to form a cartel, where the all decide to raise their prices together and control supply. Governments have to set up policies to reduce and eliminate restrictive practices that can put an unfair lead to one company or individual. Antitrust laws make it difficult for these cartels and monopolies to exist, so by enforcing them the government improves competition and avoids price fixing. To prevent one company from having a majority stake in the market the government has put in place the monopoly and merger commission. This commission researches the relative competitive position of companies, which want to merge to avoid a too strong monopolistic position in a certain segment of the market. This commission can effectively block companies from merging together. Governments can also start nationalization to diminish the domination of monopolies. Externalities are another problem that can lead to market failure. ...read more.


Provision and finance of merit goods encourages positive externalities by increasing productivity and GNP. By providing schools and hospitals the education levels rise as well as the percentage of the population able to work. Goods can also be made compulsory to enforce the use of their positive externalities. For example, the law of helmets being used on scooters and motorbikes. Governments use some policies to discourage negative externalities. They use taxation to slightly reduce supply and raise prices so that demand falls for the product. This way the negative externality is internalized. For example, the gas-guzzler tax in which the taxes for a polluting car are increased to discourage people from buying them. Permits are implied so that people have to pay to have a right to a negative externality. The more people who want to use the externality, the more demand for the permit, which leads to an increase in cost, and therefore a drop in demand and again, a reduction in negative externalities. Partial bans can be imposed to reduce the amount of users for example the smoking age of 18 in America. Complete bans for undesirable goods can also be put into place to stop the negative externality completely. Although, this is never 100% successful because of the resulting black-market for, for example, cocaine. Litigation is another form or restriction where the legal system is used to discourage negative externalties. ...read more.

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