What is Market Failure?

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What is Market Failure?

Market failure is the inability of an unregulated market to achieve allocated efficiency in certain circumstances. There are various reasons why allocated efficiency may not be achieved and these include factors such as public goods, immobility of factors with time lags in response, imperfect information, inequality, market power and externalities. There is a clear economic case for government intervention in markets where some form of market failure is taking place. Government can justify this by saying that intervention is in the public interest. There are two types of efficiency that we will briefly consider. These are allocated efficiency, which occurs when resources are distributed in such a way that no consumers could be made better off without other consumers becoming worse off, and productive efficiency, which is achieved when production is carried out at its lowest cost.

Public Goods

Certain goods and services would not be provided without the intervention of the government. We cannot perhaps imagine this country without a legal system, defence forces, schools, roads and health services but all of these goods and services are provided largely by the government although there are elements now of the private sector in each category.

A pure public good is a good or service, which is consumed by everyone and from which no one, can be excluded, defence is a good example. It has two characteristics, non-rivalry i.e. one person's consumption of the good does not reduce the amount available for someone else and non-excludability i.e. no one can be excluded from consumption of the good.

This brings in the problem of free riders, which is someone who consumes a good or service without paying for it. This problem arises with public goods because why should one person pay when everybody else will contribute to the cost. If everyone took this attitude the good would not be provided hence the need for government intervention. The usual solution to free riders is for the government to supply public goods either directly or indirectly. Hereby contracting out services, such as road gritting, in both cases funding the services through subsidy or taxation.
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Immobility of Factors and Time Lags in Response

Even under perfect competition, factors may be slow to respond to changes in demand and supply conditions. Labour is often geographically and occupationally immobile. This can lead to unemployment and high wages for those in sectors or rising demand. In the meantime other changes will occur. Thus the economy is in a continuous state of disequilibria and the long run never comes.

Imperfect Information and Inequality and Market Power

It is assumed under perfect competition that consumers have perfect knowledge about prices and products. Whilst this may ...

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