Markets - why they fail.

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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

. 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;

. 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.

3. Unfair competition - once created a monopolist may use unfair competitive practices, such as cutting prices temporarily until the competitor is forced out of business

4. Natural cost advantages - some firms are natural monopolies because not a single firm in the industry can reduce their average cost to their minimum. This is usually because that firm is experiencing economies of scale:

Purchasing Economies - bulk buying often results in a cheaper cost per unit input

Marketing Economies - The cost of advertising can be spread over more units of output

Technical Economies - A large supermarket costs less to build than a small one

Managerial Economies - large firms employ workers who specialize in specific tasks, who are therefore more qualified and efficient.

Financial Economies - large firms are more credit worthy than small firms.

5. Product Differentiation - by making their product seem very different from the competition through marketing and branding a monopoly can be established.

6. Control over outlets - so competitors cannot get their products to the market

Government may allow a monopoly to exist because:

Alone they are productively efficient because of economies of scale

Industry is dangerous and can only allow for one firm e.g.

Preventing monopoly power market failure

Government intervention on monopolies occurs because monopolies are:

Price makers- set the market price above equilibrium so their profits are high

Allocatively inefficient

. Taxes - government uses tax to remove abnormal profit.
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(evaluative): but firm still Allocatively inefficient /removal of incentive to cut costs results in productive inefficiency.

2. Subsidies - government could encourage the producer to make more and at a lower price through the use of subsidies.

(evaluative): the public is unlikely to support this, as subsidy provided by taxpayers money/ difficult to know amount of subsidy requires to achieve allocative efficiency in real terms

3. Price Controls - the government could limit the price the firm may charge, thus encouraging the firm to cut costs to sustain profits, which is efficient.

(evaluative): difficult ...

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