Market Failures

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Situations in which the market fails to allocate resources efficiently, such as when there is a monopoly or when there are negative externalities.

Definition and types of market failures: Understanding what market failures are and the various types of market failures, such as externalities, public goods, and imperfect competition.
Externalities: This refers to costs or benefits of economic activities that accrue to third parties outside the market transaction. It could be positive or negative and occurs when the actions of one person or entity affects the well-being of another, without compensation.
Public goods: This refers to goods that are non-rivalrous and non-excludable in consumption. They are typically under-supplied by the market as individuals under-consume them for fear of free-riders, so authorities typically intervene to provide them.
Imperfect competition: This refers to situations where the market price is not equal to the marginal cost of production, leading to under or overproduction of goods and services.
Asymmetric information: This refers to situations where one party in a transaction has more or better information than the other, leading to inefficient outcomes.
Moral hazard: This is a situation where one party is insulated from the risk of loss, leading to excessive risk-taking behavior.
Adverse selection: This is a situation where one party has more information about the product or service being traded than the other leading to non-optimal outcomes.
Government interventions: Various government interventions are utilized to mitigate market failures. Such methods include subsidies, taxes, regulation, and public provision.
Market power and antitrust: This refers to the ability of a firm or group of firms to control the price and production level in the market, leading to inefficient outcomes. Governments can also intervene in such situations utilizing antitrust laws.
Efficiency and equity implications of market failures: Understanding the implications of market failures on economic efficiency and equity, and how government policy can address these.
Externalities –Externalities refer to the costs or benefits that are not captured by the market transactions: This results in a failure to allocate resources efficiently, and creates welfare losses.
Information asymmetry: This refers to the situation where there is a lack of complete information between market participants, leading to market failure since buyers and sellers cannot make informed decisions.
Public goods –These refer to goods or services that are non-excludable and non-rival in consumption: The failure occurs since private firms will not supply public goods for profit, resulting in market inefficiencies.
Natural Monopolies –This occurs when a single firm can supply a good or service at a lower cost than multiple firms: This can lead to inefficiencies since competition among industries will not exist.
Price inflexibility: Price inflexibility refers to situations where prices are unable to adjust to equilibrium, resulting in excess demand or supply in the market.
Principal-Agent Problem: Principal-Agent problem refers to the misalignment of incentives between the agent and principal, causing market efficiency issues.
Regulatory capture: This happens when market regulators become influenced by industries or groups they were created to oversee.
Market power abuse: This occurs when a firm holds a significant market share, enabling it to manipulate prices or restrict entry by potential competitors.
Poor labor market outcomes: This occurs when markets fail to provide decent work opportunities to the labor force, leading to economic inequality and social welfare losses.
- "Market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value."
- "Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient – that can be improved upon from the societal point of view."
- "The first known use of the term by economists was in 1958."
- "Market failures are often associated with public goods, time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, or externalities."
- "The existence of a market failure is often the reason that self-regulatory organizations, governments or supra-national institutions intervene in a particular market."
- "Such analysis plays an important role in many types of public policy decisions and studies."
- "However, government policy interventions, such as taxes, subsidies, wage and price controls, and regulations, may also lead to an inefficient allocation of resources, sometimes called government failure."
- "Most mainstream economists believe that there are circumstances (like building codes or endangered species) in which it is possible for government or other organizations to improve the inefficient market outcome."
- "Several heterodox schools of thought disagree with this as a matter of ideology."
- "An ecological market failure exists when human activity in a market economy is exhausting critical non-renewable resources, disrupting fragile ecosystems, or overloading biospheric waste absorption capacities."
- "In none of these cases does the criterion of Pareto efficiency obtain."
- "It is critical to create checks on human activities that cause societal negative externalities."
- "Market failures are often associated with... information asymmetries."
- "Market failures are often associated with... principal–agent problems."
- "Market failures are often associated with... non-competitive markets."
- "Government policy interventions, such as taxes, subsidies, wage and price controls, and regulations, may also lead to an inefficient allocation of resources..."
- "Market failures are often associated with... time-inconsistent preferences."
- "Most mainstream economists believe that there are circumstances... in which it is possible for government or other organizations to improve the inefficient market outcome."
- "The concept has been traced back to the Victorian philosopher Henry Sidgwick."
- "Economists, especially microeconomists, are often concerned with the causes of market failure and possible means of correction."