Market Failure
Market Failure
"As long as producers and consumers act as perfect competitors, that is, take prices as given, then under certain conditions, a Pareto efficient allocation of resources emerges" - Fundamental Theorem of Welfare Economics Pareto Efficient Allocation is a point of efficiency, wherein the only way to make one agent better off is to make others worse off Governments have two reasons for their activity - Tax Collection and Public Expenditure - Regulate Market Failures Market Failure - Is an economic situation where resources are misallocated - May be caused by two possible factors: ○ Market Power ○ Non-existence of Markets Why is Market Power a source of Failure? - Marginal Cost Pricing is not practised (P > MC) - There is a tendency for firms to behave according to profit-maximization motive because they have market power. - This type of market failure is borne from Imperfect Competition Non-Existence of Markets - The non-existence of a market would mean that we can hardly expect the resource to be allocated efficiently. - Many forms of market failure are borne from this: ○ Information Asymmetry ○ Externalities ○ Public Goods Conditions of Market Failures 1. Imperfect Competition - Monopoly, Oligopoly and Monopolistic Competition entail P > MC - This would result to consumers paying more than the true cost of production and that they consume less, thus leading to this being an inefficiency - Economic Rent/Rent-Seeking Activities - premium paid by monopolies to governments to protect monopoly position. Economic Rent is defined as the difference in price when P > MC and P = MC - How do we regulate Monopolies? Price Controls, Lump Sum taxes, Excise and Specific Taxes Taxes (particularly excise) , however, has its own distorting effects on the economy, as it raises prices and decreases quantities 2. Public Goods - A good exhibiting the characteristics: Non-rival in consumption - the consumption of one does not deprive others of the good
"As long as producers and consumers act as perfect competitors, that is, take prices as given, then under certain conditions, a Pareto efficient allocation of resources emerges" - Fundamental Theorem of Welfare Economics Pareto Efficient Allocation is a point of efficiency, wherein the only way to make one agent better off is to make others worse off Governments have two reasons for their activity - Tax Collection and Public Expenditure - Regulate Market Failures Market Failure - Is an economic situation where resources are misallocated - May be caused by two possible factors: ○ Market Power ○ Non-existence of Markets Why is Market Power a source of Failure? - Marginal Cost Pricing is not practised (P > MC) - There is a tendency for firms to behave according to profit-maximization motive because they have market power. - This type of market failure is borne from Imperfect Competition Non-Existence of Markets - The non-existence of a market would mean that we can hardly expect the resource to be allocated efficiently. - Many forms of market failure are borne from this: ○ Information Asymmetry ○ Externalities ○ Public Goods Conditions of Market Failures 1. Imperfect Competition - Monopoly, Oligopoly and Monopolistic Competition entail P > MC - This would result to consumers paying more than the true cost of production and that they consume less, thus leading to this being an inefficiency - Economic Rent/Rent-Seeking Activities - premium paid by monopolies to governments to protect monopoly position. Economic Rent is defined as the difference in price when P > MC and P = MC - How do we regulate Monopolies? Price Controls, Lump Sum taxes, Excise and Specific Taxes Taxes (particularly excise) , however, has its own distorting effects on the economy, as it raises prices and decreases quantities 2. Public Goods - A good exhibiting the characteristics: Non-rival in consumption - the consumption of one does not deprive others of the good