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What are the sources of market failure?

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What are 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. ...read more.


Some examples of negative externalities include cigarette smoking and vehicle exhaust. Externalities arise because the free marker mechanism fails to take into account the differences between the private and social costs and benefits in an economic activity. The free marker only responds to purely private price signals. In other words, private costs and private benefits determine what goods and bought and sold in the free market. Pure public goods have very strong spillover of externalities. They are characterized by non-excludability and non - rivalry. Examples include defense, law and order, street lighting and lighthouses. It is generally not possible to exclude people from these services. Public goods are also non-rival in that one person's use of the good does not deprive any other person of the use of the good as well. For example, if one person benefits from the peace and security in a country that is provided for the armed forces and the police force, this does not mean that this person can use up this peace and security. ...read more.


The cost of cigarette smoking is borne by the government providing health care services and the nation, as there will be a loss in national productivity. This implies a suboptimal allocation of resources because the market price is less that the true price of consumption, and thereby encourages over consumption of such goods. It has been argued that the free market fails to allocate resources efficiently according t o what the people and society needs. A major criticism of the free market mechanism is that it allocated resources based on effective demand, that is, demand back by purchasing power than on demand based on the needs of a society. The free market system is able to allocate scarce economic resources efficiently if private costs are the same as social costs, and private benefits are the same as social benefits. But in the most cases, they are not the same. It is then argued that the price mechanism fails to take into account social cost and social benefits, and therefore fails in its role to allocate resources to their optimum use. Market failure is the result of a sub optimal allocation of resources in a country. (b) ...read more.

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