Explain the Main Sources of Market Failure that Can Occur in the Market System and Discuss the Positive and Negative Effects of Government Intervention to Deal with these

by sanghyunlee (student)

Sang Hyun Lee

McCartney

11th July, 2012

Explain the Main Sources of Market Failure that Can Occur in the Market System and

Discuss the Positive and Negative Effects of Government Intervention to Deal with these

Government to intervene in order to maintain the free market is not only unnecessary, it would be very wrong. Companies in the inadequate intervention by the outside power fundamentally contradict the purpose of the free market. This is a good or bad thing? This paper focuses on that the definition of market failure, how the free market works, and main sources of market failure, the positive and negative effect on government intervention. Market failure occurs when free markets fail to allocate efficient or optimal resources. Therefore economic and social welfare will not maximize. This causes to a loss of economic efficiency.

figure 1: < Market price in free market >

Not government but private owners are the owner of free market economy about all the factors of production; capital, land and labour. As you can see figure 1, the market price to meet demand and supply curve achieves the equilibrium price. If the equilibrium price gets out of the point of intersection, it means that government intervention cause to government failure in the long run. Classical economists said that government intervention only makes economy worse. The free market is not always efficient and the government has a role to play in ensuring that the market is efficient (Keynes 2007). Now, the paper will focus on the main sources of market failure and the positive and negative effect on government intervention.

This paragraph will discuss about the main sources of market failure. There are six sources in market failure. In the free market economy, there are 6 main sources of market failure; such as information failure, factor immobility and inequality issues. Information failure is caused by imperfect information and information gaps. Someone who has inaccurate or misunderstanding information exists in the free market. Factor immobility occurs when the factor of production is not moved between two regions. Inequality in economy means that ability of individual to consume services or goods relys on their own properties. But this essay will focus on other three sources of market failure; externalities, missing market and lack of competition. First, externalities make a difference between private and social costs and benefits. Externalities occur when a third person who has nothing to do with the decision to practice is affected by cost or benefit. There are negative externalities. Negative externalities can occur a production impose external cost to third person who isn’t given compensation. There is a concrete example of negative externalities. America pollution made by producers and consumers can bring about external costs in Britain. It is the effects of the nuclear fallout from the Chernobyl disaster in 1986. Nowadays, polluted air from America damaged to Britain people’s health. The Intercontinental Transport of Ozone and Precursors programme found that chemicals in the air which is 8,000km away. It is deposited in the Britain and Western Europe and may cause increasing lung disease (Geoff 2006). As you can see below diagram, this provides a way of picture the effects of negative externalities caused by production. The important thing is to know that difference between private and social costs.

Figure 2: <Market failure from negative externalities>

(<as-marketfailure-negative-externalities_clip_image007.jpg> n.d.).

This is a preview of the whole essay

Figure 2: <Market failure from negative externalities>

(<as-marketfailure-negative-externalities_clip_image007.jpg> n.d.).

Second, usually, free market economy will fail to deliver efficiently certain public goods and services. To provide pure public items, tax, or duty charges are supplied through other forms. This is a subjective judgment on the derived benefits. Example of missing market, there are a lot of goods that have a public factor however they are not public goods. Like, congested motorway. Third, market failure under monopoly is main source of market failure. Imperfect competition can cause to market failure. Monopolists waste scarce resources. It means that high quality of marketing designed to raise brand loyalty and construct barriers of entry. The monopoly of private business is quite unusual case. As a matter of fact, many governments in the world have particular provisions to intervene monopolistic market. The example of similar situation about monopoly in real world is Microsoft which product is homogeneous. In their situation, one seller is dominating the market and there are high barriers to entry. For a long time, Microsoft has owned not only Internet Explorer but also most popular operating system which is Windows. Therefore, Microsoft launches a new version of windows that can be used for browser, it reduce the exact need for another browsers. Hence, the competition is made useless thing (Krishna 2009). These three things are the main sources of market failure.

This paragraph will discuss about the positive and negative effects of government intervention. Government intervention occurs when the country interferes with the individual market’s working as like controlling prices. Because of above main sources, the government should need to intervene to solve the market failure. Generally, government can intervene through one of the following things: tax, subsidy and regulation. First, taxes are needed so as to access the cost to society of a negative externality. Many proponents of taxes said that taxation is extreme measures in modern society economic stream. Taxes have positive as well as negative features in economic system. Increased taxes can affect immediately to consumers, cooperation and the overall economic because they are exposed to effects of taxes. It means consumers have negative effects on taxes because they lose out of their money to spend more by increased price. It makes consumer extravagant. However, another point of same view on consumer is the saving aspect of consuming. They tend to spend less on goods or services. Therefore, consumers have more money in bank and it makes market works efficient in overall perspective. Second, subsidies operate such kind of the opposite way to taxes. They are direct payment in government to firms and businesses. The aim of subsidy is reducing the cost of goods or services in order to make cheaper price of them. Subsidies is regarded as a way of protection or trade barrier which makes domestic goods and services artificial. If the perfect market assumption is relaxed, subsidy increases the quality of welfare. And an efficient subsidy can correct market failure. But there is a negative effect on subsidy. In developing industry, they can make the market industry less competitive by giving a subsidy the poor part of market. Subsidies is not good for developing country in industry and in doing so maintain the poorer companies well, thereby disturbing long term growth. Lastly, government can pass the law which ban the sale of alcohol or smoking in common place. Such like these regulations may be useful for making fresh competition. For example, laws can break up the existing monopoly power in competition market. A real example of this is the competition for British Telecom. This is known as market liberalisation. But government regulations do not always work on intended way. They can impose a lot of costs on the poor. The more citizens are to escape laws, the less effective they are.

Up to now, this essay discussed about two main points. The first thing was three main sources of market failure like externalities, missing market, and lack of competition and the second point was positive and negative effects of government intervention such as tax, subsidy, and regulation. To sum up, Government intervention in the free market is basically aimed in declining inequalities and injustices of market failure even though there are some risks of occurring other economic problems.

Word Count : 1,334

References

Geoff, R., 2006, AS Market Failure,- tutor2u, viewed 9 July 2012,

http://tutor2u.net/economics/revision-notes/as-marketfailure-negative-externalities.html

Geoff, R., 2006, Illustrating Market Failure from Negative Externalities.

“Illustrating Market Failure from Negative Externalities”, September 2012.

http://tutor2u.net/economics/revision-notes/as-marketfailure-negative-externalities.html.

Krishna, agrawala, 2009. Give real life examples of a monopoly, perfect competition, oligopoly, monopolistic competition and duopoly in India. [WWW Document]. http://www.enotes.com/business/q-and-a/give-real-life-examples-monopoly-perfect-111737/

Maynard Keynes, 2007, The General Theory of Employment Interest and Money,

Hampshire: Macmillan press, viewed 8 July 2012, <http://essayblog.org/wp-

content/samples/BusinessEconomics.pdf>