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Market Failure Assignment Help

The concept of market failure is not strictly restricted to the market economy. It refers to a situation where individuals in a group prioritise their interests, which ends up working negatively towards the group as a whole.

Market Failure Definition

Market failure is defined by the situation that arises due to insufficient goods distribution in the free market. This situation occurs when individuals prioritise their gains rather than what works best as a group.

This kind of market failure can occur in both implicit and explicit markets. An implicit market is a kind where behind-the-doors favors and special treatments are exchanged. Meanwhile, an explicit market is a typical market where sellers and consumers sell and buy goods.

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Market Failure Examples

Market failure usually arises when the free market fails to allocate the goods and resources efficiently. If you look around yourself, you’ll find plenty of market failure examples that you can refer to for a better understanding of the topic.

Air pollution

In many cases, the cost of the market failure is not reflected in the price. The increased air pollution in the air is one such example. Pollution creates a significant amount of third-party costs that can have harmful effects on the health of human beings. However, none of the corporations contributing to air pollution reimburses the third parties for affecting their health. This is called a negative externality.

The US Healthcare

When you compare the different free-market economies, despite the US having the highest per capita health expenditure, most Americans are unsatisfied with their healthcare. This is due to many reasons, such as-

No access to the healthcare system
Lack of information
A monopoly of the market
High fees

The monopolistic tendencies of the healthcare system make it possible for different physicians to charge as much as they want for the same services. Moreover, various sub-specialists also lead to an excess of medical costs.

The US Dairy System

The US dairy system is a classic example of market failure. In this case, farmers produce an excess of dairy to be eligible for government subsidies. However, this results in the supply overshadowing the demand in the market. The government has no option but to store the excess dairy. Yet, even though this can mean fewer profits as a whole, the suppliers continue to over-produce dairy for their selfish gains.

Other examples of market failure include:

Creating public goods like street lamps or parks
Housing financial asset bubble
Free trade
Climate change

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What Does The Term Market Failure Refer To?

The term ‘market failure’ refers to that moment when the price mechanism fails to consider all the costs and benefits necessary to provide and consume a good or product. This happens when the market fails to supply the optimal quantity of goods where the price reflects the marginal consumption benefit.

There can be two types of market failure- complete and partial.

Complete market failure– This refers to the situation where the market completely stops supplying products, resulting in missing markets. For example, if the consumers want green tea, but all the producers stop the supply of green tea, then there is a missing market for that product.
Partial market failure – This refers to when the market does not supply the correct quantity of the demanded product or supplies it at prices the consumers won’t pay. For example, this situation will occur if the market supplies less than the demanded quantity of green tea or if the price is so high that the consumers cannot buy it.

What Is A Source Of Market Failure?

Market failure occurs when individuals act in rational self-interest and produce fewer quantities of a product than demanded. Hence, public goods are one significant source of market failure.

Any individual can use a public good. This does not reduce the opportunity for others to use the same service. For example, a lighthouse is a public good that shines its light on all ships without discrimination.

A public good is non-excludable; that is, no one can be denied from using its services. It is also non-rivalrous as not one single individual holds the rights over the public good.

Therefore, anyone can use public goods, regardless of whether they pay to use the service or not. As a result, public goods are underproduced as there is little profit in them.

Market Failure In Economics

You can find the development of the term ‘market failure’ in economics from around the middle of the 20th century. The main concern of the theorists, such as Pigou, Bator, Baumol, and Samuelson, was the relation between the free-market outcomes and social welfare optimization.

In standard economics, the free market and the socially optimal distribution go hand in hand. However, this ideal situation can arise when you assume perfect competition, complete markets, and no market failures.

Market failure occurs in three situations – when the economies of scale increase regardless of the production amount, public goods, and when the production or consumption has externalities.

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How Do Property Rights Affect Externalities And Market Failure?

In economics, an externality is a collateral that a third party has to bear due to the business deals of others. These externalities can be positive and negative, depending on how it affects the third party.

Private properties are often at the center of such externalities. They are used as the main bargaining chip for those who are affected by these externalities.

Suppose you live next to a factory, and the smoke emitting from there is a negative externality that gives you health complications and lowers your property value. As the property owner, you have the right to seek redressal for these grievances. You can also use property rights to transfer costs and benefits.

Market failure occurs when private properties are not defined clearly or protected adequately. For example, individual drivers have no personal property right on the roads. As a result, there is no solution to traffic congestion as it is public property.

Other Sources Of Market Failure

Market failure has plenty of other sources than the lack of public goods. These are:

Externalities

Externalities are the collateral effect on third parties due to the consumption and production of a service. It can be both positive and negative.

A positive externality occurs when the third party is impacted positively. For example, public education as an educated person can contribute to the welfare of society.
A negative externality occurs when the third party is negatively affected. For example, a person can have serious health effects due to passive smoking despite not touching a cigarette in their life.

Underproduction of merit goods

Merit goods are often underproduced, despite the positive externalities that come with them. For example, healthcare and education.

Overproduction of demerit goods

The overproduction of goods that give rise to negative externalities contribute to market failure. For example, alcohol and cigarettes.

Power monopoly

Market failure also occurs when individuals give more attention to personal profit and restrict the production of goods.

In times of market failure, the government has to interfere and introduce taxes, tariffs, laws and trade restrictions.

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