Market failure occurs when freely-functioning markets, fail to deliver an efficient allocation of resources - directly linked to production. Market failure exists when the competitive outcome of markets is not efficient from the point of view of society as a whole.
Markets can fail because of:
- Negative externalities (e.g. the effects of environmental pollution) causing the social cost of production to exceed the private cost.
- Positive (or beneficial) externalities (e.g. the provision of education and health care) causing the social benefit of consumption to exceed the private benefit.
- Imperfect information means merit goods are under-produced while demerit goods are over-produced or over-consumed.
- The private sector in a free-markets cannot profitably supply to consumers pure public goodsand quasi-public goods that are needed to meet people’s needs and wants.
- Market dominance by monopolies can lead to under-production and higher prices than would exist under conditions of competition.
- Factor immobility causes unemployment hence productive inefficiency.
- Equity (fairness) issues. Markets can generate an ‘unacceptable’ distribution of income and consequent social exclusion which the government may choose to change.
Market failure results in
- Productive inefficiency: Businesses are not maximising output from given factor inputs. This is a problem because the lost output from inefficient production could have been used to satisfy more wants and needs.
- Allocative inefficiency: Resources are misallocated and producing goods and services not wanted by consumers. This is a problem because resources can be put to a better use making products that consumers value more highly.
Examples of Market Failure
http://webarchive.nationalarchives.gov.uk/+/http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm
“Climate change presents a unique challenge for economics: it is the greatest and widest-ranging market failure ever seen”
The main concept is that climate change is a result of the externality associated with greenhouse-gas emissions – it entails costs that are not paid for by those who create the emissions"
Cartels and Collusion
Different froms of Collusion...
- Cartels
- Joint product developments
- Horizontal and vertical collusion
- Overt and covert collusion
Collusion represents an attempt by firms to recognize their interdependence and act together rather than compete.
Collusion can be seen as a move towards joint-profit maximization.
Collusion normally requires control over the market supply of a commodity.
Most collusive activity takes place between firms in the same industry e.g.
- bus service operators
- car body part supplies
- steel producers within the EU
- Independent schools
Cartels
An association of manufacturers or suppliers that maintains prices at a high level and restricts competition.
E.g. Football shirt industry
Price fixing and the law...
- Agree prices with your competitors
- share markets or limit production to raise prices
- impose minimum prices on different distributors e.g. shops
- cut prices below costs to force smaller, weaker firms out of the market
Argos and Littlewoods were fines £22.65 million by the OFT for fixing the price of toys and games together with Hasbro in breach of the competition act 1988.
Competition commission and EU commission
The Competition Commission is a non-departmental market body responsible for investigating mergers, markets and other enquiries related to regulated industries under competition law in the United Kingdom.
Positive and negative externalities
An externality is defined as a benefit or cost that is imposed on a third party, such as society, other than the producer or consumer of a good or service, or, more simply, an economic side effect. The more of a product that is consumed or produced, the more of an externality that results. When discussing externalities in general terms, positive externalities refer to the benefits and negative externalities refer to the costs associated with the production or comumption of a good or service.
Externalities are not ususally fully reflected in prices. Externalities are regarded as a form of market failure. The costs and benefits related to externalities are not typically included as part of the decision to complete the economic activity. Given this, the chosen volume or frequency of activity is not directly related to the externality and becomes an inefficiency in terms of resource use. Negative externalites cause too much of a product to be produced and positive externalities cause too little of a product's production. When considered as a supply-demand graph for a positive externality, the marginal benefit curve perceived by the decision maker will be to the left of the marginal benefit curve of society. This shows too little activity taking place.
Public goods are one of the more common examples of positive externalities. Public goods are goods which are difficult to exclude people from benefiting from or from getting a free ride. Public goods, such as national defense, clean water, clean air, law enforcement, etc., are generally good for most, if not all of society.
Negative externalities exist in many situations. One of the most common examples is that of pollution. In these situations, the producer and consumer finance the goods produced but society must bear the cost of pollution that is introduced into the environment as a by-product and is thus a negative externality. For example, a factory that produces widgets generates a hazardous by-product from the widget production process. It dumps the by-product in neighboring stream. The more widgets produced, the more by-product is produced and thus the more pollution that goes into the water. The factory may bear some of the cost of the pollution but not all. Any remaining cost is borne by society. In this situation and in the event of the absence of well defined property rights there may be an issue of how much pollution may be dumped into the water or if it can be dumped into the water at all plus an issue over who is responsible for the cost of the pollution. In the absence of well defined property rights, it may be necessary for the government to step in to introduce regulation, legislation, taxes, etc. to address the situation. An example where the government addressed an issue was the Clean Air Act.
China's Externalities
http://www.vice.com/toxic/toxic-linfen-china
http://www.vice.com/toxic/toxic-linfen-china#ooid=x1cHdrMjoYZNPC8Onj-qaRNgmpQhclXu
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