Meaning And Causes Of Market Failure

MARKET FAILURE

Market failure is an economic term that involves a situation where, in any given market, the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers.

Market failure occurs when resources are misallocated, or allocated inefficiently. In other words, market failure occurs when markets fail to produce and allocate scarce resources in the most efficient way; i.e., the market may not always allocate scarce resources efficiently in a way that achieves the highest total social welfare.

Causes of Market Failure

Markets do not function in a perfect manner as they are expected to do so in a theoretical model. They fail to perform efficiently due to a number of reasons such as availability of public goods, business corporates acquiring monopoly power in real world market which is full of imperfections, externalities arising out of economic activities, imperfect or asymmetric information, inequal income distribution and many other factors. Let us briefly discuss these factors.

1. PUBLIC GOODS

Most goods in the economy are allocated in market, where buyers pay for what they receive and sellers are paid for what they provide.For these goods, prices are the signals that guide the decisions of buyers and sellers, and these decisions lead to an efficient allocation of resources.

2.MARKET POWER

An imperfectly competitive market is one where the assumption of many buyers and sellers does not hold. These types of market organisations include monopoly,monopsony, oligopoly, and monopolistic competition.

None of these markets are efficient. In general, the firms do not produce the socially optimal quantities (they tend to under-produce) and the price is higher than it would be under perfect competition.The condition P=MC does not hold, and the system does not produce the most efficient product mix.

3. EXTERNALITIES

An externality arises when a person engages in an activity that influences the well-being of a bystander (or third party) and yet neither pays nor receives any compensation for that effect. Third parties are individuals, organisations, or communities indirectly benefiting or suffering as a result of the actions of consumers and producers attempting to pursue their own self-interest. The potential market failure arising from externalities is that the social optimum output or level of consumption diverges from the private optimum.

6. MISSING MARKETS AND INCOMPLETE MARKETS

A market is considered to be complete when it provides all goods and services for which the cost of provision is less than what individuals are willing to pay. Whenever private markets fail to provide a good or service even though the cost of providing it is less than what individuals are willing to pay, they are considered as incomplete markets. Incomplete markets are the cases of market failures.

A missing market is a situation where resource allocation based on a competitive market does not exist. Missing markets are nothing but market failures. Externalities, public goods, etc. are the cases of missing markets.

7.MERIT GOODS

Merit Goods are those goods and services that the government feels that people left to themselves will under-consume and which therefore ought to be subsidised or provided free at the point of use.

Both the public and private sector of the economy can provide merit goods and services.

8.UNSTABLE MARKETS

Sometimes markets become highly unstable, and a stable equilibrium may not be established, such as with certain agricultural markets, foreign exchange, and credit markets. Such volatility may require intervention.

9.DE-MERIT GOODS

Markets may also fail to control the manufacture and sale of goods like cigarettes and alcohol, which have less merit than consumers perceive.