Economics of market failure - There is a clear economic case for government intervention in markets where some form of market failure is taking place.

Public Goods

Public Goods not provided by the free market because of their two main characteristics

* Non-excludability where it is not possible to provide a good or service to one person without it thereby being available for others to enjoy

* Non-rivalry where the consumption of a good or service by one person will not prevent others from enjoying it

Examples: Streetlighting / Lighthouse Protection, Police services, Air defence systems, Roads / motorways, Terrestrial television, Flood defence systems, Public parks & beaches

Because of their nature the private sector is unlikely to be willing and able to provide public goods. The government therefore provides them for collective consumption and finances them through general taxation.

Merit Goods

Merit Goods are those goods and services that the government feels that people left to themselves will under-consume and which therefore ought to be subsidised or provided free at the point of use.

Both the public and private sector of the economy can provide merit goods & services. Consumption of merit goods is thought to generate positive externality effects where the social benefit from consumption exceeds the private benefit.

Examples: Health services, Education, Work Training, Public Libraries, Citizen's Advice, Innoculations

Monopoly

Few modern markets meet the stringent conditions required for a perfectly competitive market. The existence of monopoly power is often thought to create the potential for market failure and a need for intervention to correct for some of the welfare consequences of monopoly power.

The classical economic case against monopoly is that

* Price is higher and output is lower under monopoly than in a competitive market

* This causes a net economic welfare loss of both consumer and producer surplus

* Price > marginal cost - leading to allocative inefficiency and a pareto sub-optimal equilibrium. See also the study page on economic efficiency

* Rent seeking behaviour by the monopolist might add to the standard costs of monopoly. This includes high (possibly excessive) amounts of spending on persuasive advertising and marketing.

* Libenstein's X-inefficiency may also result if the monopolist allows cost efficiency to drop. An upward drift in costs because of a lack of effective competition in the market-place can lead to consumers facing higher prices and a reduction in their real standard of living

For further revision notes in our study area on monopoly go to this page

Externalities

Any exam question on market failure must make some reference to externalities. What are the potential market failures arising from externalities?

The social optimum output or level of consumption diverges from the private optimum.

Main problem is the absence of clearly defined property rights for those agents operating in the market. When property rights are not clearly defined, market failure is likely because producers & consumers may not be held to account

Don't forget that positive externalities can also justify intervention if goods are under-consumed (social benefit > private benefit)

For further revision notes on externalities go to this page