Monopoly power one of the causes of market failure, this breaks the fundamental rule – marginal cost = marginal revenue = price, by separating the marginal cost of the production of a good and the utility it provides the marginal consumer as measured by prices. Monopoly pricing also creates an income distribution effect. In a monopoly it is the consumers who lose out as they pay higher prices than what they would have to pay in a competitive market.
Firms gain from consumers is not the entire economic case against uncompetitive behaviour. The problem with a monopoly is that economic efficiency is reduced when firms get monopoly power. When a competitive market moves to a monopolistic market, the large quantity supplied at a low price changes to a smaller quantity supplied at a higher price. This causes a net loss of utility to society on a whole. This is known as the ‘dead-weight loss’ of monopoly. The ‘dead-weight loss’ problem is an inert occurrence relating to the market situation at one point in time.
Monopolies become less efficient over time, monopolies have less incentive than competitive firms to maintain efficiency, to innovate and to improve their services. This is a central them of the Austrian School, as opposed to the neo-classical view. The pressure of competition drives firms to lower marginal costs regularly, while costs and output quality don’t worry sheltered firms.
Oligopoly is another cause of market failure, it is another form of imperfect competition. This type of market contains a small number of firms, each able to affect the market price. An important feature of this structure is firms are independent. Oligopolistic firms are mutually exclusive, but if they do decide to compete they act similarly to perfect competition. Products are usually differentiated, allow in some markets products are identical. For example the basic commodity market, for example tin, copper, silver, etc.
Externalities are another cause for market failure; externalities I think are best described as ‘overflow effects’. Overflow effects occur when an economic activity affects a third party who never had any say in the actions, which created this effect. The effects of ‘over-flow’ show the inefficiency of the free market system.
There are two types of externalities, positive and negative. Positive externalities, also known as external benefits, provide benefit to a third party. For example, a software house trains a person in programming skills, these skills can be passed on at zero cost to another software house if the employee changes job. Negative externalities also known as external costs, involves a loss of utility, adding a cost to a third party. For example, a chemical plant that cause water pollution in a river, a factory downstream that needs clean water must incur a cost to clean the water that the chemical plant has polluted.
There are different types of externalities, which are shown in the table, on the next page.
Figure 1.2
There are 4 different categories of externalities, all of which cause inefficiency in the free market. The free market doesn’t provide enough positive externalities and provides too many negative externalities, it is safe to say that positive externalities are as inefficient as negative externalities.
Public goods are one of the other causes of market failure. A public good is non-excludable and non-rivalrous in consumption. A good example of explaining public goods are television broadcasts, a person needs a television to receive broadcasts. Also they must legally have a television license, whether a person has a license does not prevent them receiving broadcasts, however without a television they can’t. Television broadcasts are non-excludable; the self-interested individual will risk paying for a television license as other people will pay for a license. If everyone took this attitude, there would be no television broadcasts (No BBC channels, unless they commericalised.).
The term ‘non-rivalry’ is used by economists, means that the consumption of a good by an additional person does not prevent another person consuming it. A non-rivalrous had a zero marginal cost of consumption.
A private good, the opposite of a public good is excludable, only one person may consume it. For example a currant bun, if I eat the bun, it is gone. No one else can enjoy eating it. Therefore a private good is excludable; a good is excludable if individuals can be prevented from enjoying its benefits.
It is impossible to separate goods into the private and public categories; there is a limitless range of goods. The diagram below indicates the position of some goods that fall between the two categories.
Figure 1.3 - Private goods and Public goods (excludability).
Pure public goods cause market failure because of the ‘free-rider’ problem. A public good might be very costly to provide (National Health Service.) but everyone can benefit regardless if they have contributed to its financing. Self-interested individuals try to avoid paying for the good, as others will pay for its provision. Utility maximising individuals try to ‘free-ride’ on others.
The fourth type or market failure comes about because consumers and producers are not perfectly informed about all goods and prices. The lack of information leads to information failure or ‘mis-information’. This creates inefficient outcomes in a market system. A good example is the health risks from tobacco, in a free market a firm has no incentive to provide information on the health risks associated with smoking. Information failures also provide a rationale for public sector involvement in activities, for example drugs testing, health and safety inspectorates, banking regulations and employment and training centres.
All five of these market failures seem to indicate to the need for government intervention. This has lead to government to take responsibility for bringing equality between social costs and social benefits.
In conclusion to this essay on market failures, government intervention exists in all countries. Successful governments have widely distinct stages of intervention. The optimum stage of intervention diversifies among countries and within countries over a period of time. There is nothing in economic theory to support the view that business should be against government expansion. Michael Porter illustrates the campaign by the Japanese government to raise focus to the quality and remove the view of ‘cheap’ Japanese goods.
Efficiency is only one of the two criteria supporting economic decisions. Equity factors often favour more rather than less state intervention. The decision on what level of equity to acquire – particularly if it causes disunity with the maximisation of efficiency – cannot be made by either the economist or business, but must be decided by the ballot.
Textbooks
-
McAleese, D (1997) Economics for Business, Hemel Hempstead, Prentice Hall.
-
Turley, G et al (1997) Principles of Economics an Irish Textbook, Gill and Macmillian.
-
Black J (1997) Oxford Dictionary of Economics, Oxford University Press Inc., New York.
References
-
Figure 1.1, Principles of Economics an Irish Textbook, Chapter 7.
-
Figure 1.2, Economics for Business, Chapter 8.
-
Figure 1.3, Economics for Business, Chapter 8.
