Dr. Moyi Harry Ruben

We cannot rely on markets to provide all goods in efficient amounts. Market failure to make goods and services available in cases for which the marginal social benefits of the goods outweigh the marginal social costs of those goods or services often results in demands for government action. The following forms of market failure to achieve efficient outcomes are commonly used as a basis for recommending government intervention in markets or government provision of services:

1. Exercise of Monopoly Power in Markets. When markets are dominated by only a few firms or by a single firm, the potential exists for the exercise of monopoly power. Firms exercising monopoly power can add to their profits by adjusting prices to the point at which marginal revenue equals their marginal private costs without fear of new entrants into the market. To prevent monopoly control over price, governments typically monitor markets to ensure that barriers to entry leaving the market do not encourage the exercise of monopoly power. Governments also often regulate the pricing policies of monopoly producers of such services as Electric power, Natural gas, Solid Waste and Water.

2. Effects of Market Transactions on Third Parties. Other Than Buyers and Sellers. When market transactions result in damaging or beneficial effects on third parties who do not participate in the decision, the result will be inefficiency. When the effects are negative, people demand government policies to reduce the damaging or beneficial effects of market transactions on third parties who do not participate in such decisions. For example, exhaust fumes from cars, trucks, buses, heating systems, Generators, and power plants decrease air quality and impair public health.  When the effects are beneficial, government policies are often used to encourage production of the item benefiting third parties. This is often the case for education, fire protection, and inoculations for contagious diseases.

3. Lack of a Market for a Good with a Marginal Social Benefit That Exceeds Its Marginal Social Cost. In many cases, useful goods and services cannot be provided efficiently through markets because it is impossible or difficult to sell the good by the unit. Benefits of such goods can be shared only. These goods are called “public” goods to distinguish them from private goods, which are consumed by individuals and whose benefits are not shared with others who do not make the purchase. A distinguishing characteristic of public goods is that a given quantity of such goods can be enjoyed by additional consumers at no reduction in benefits to existing consumers. National defense is an example of a public good having this property. Increases in population occur daily, and the additional population can be defended without any reduction in benefits to the existing population. Another characteristic of public goods is that their benefits cannot be easily withheld from people who choose not to contribute to their finance. Even if you refuse to pay the costs of national defense, you still will be defended. This means that firms selling public goods, like national defense, will have great difficulty collecting revenue necessary to finance costs to produce such goods. I will discuss the characteristics of public goods in detail and explains why it is likely that such goods will be supplied in less than efficient amounts if markets are used to make them available. In many cases, government provision of goods is justified because of a conviction that the marginal social benefit of the good exceeds the marginal social cost at quantities that would result if the good were supplied through markets. For example, government provision of health insurance, deposit insurance, and flood insurance are common because many persons believe that these are useful services that cannot be provided profitably in efficient amounts by profit-maximizing firms selling in competitive markets. Similarly, direct payments or subsidized loans to students attending institutions of higher education are often justified by arguing that government should encourage education because the marginal social benefits of its consumption exceed the marginal private benefits received by individual students.

4. Incomplete Information. We often demand that government intervene in markets because we have incomplete information about the risks of purchasing certain products or working in certain occupations. For example, we rely on government to test new drugs and to prevent hazardous products from being sold. We also rely on government to establish standards for safety in the workplace.

5. Economic Stabilization. Market imperfections, such as downwardly rigid wages, give rise to excessive unemployment in response to decreases in aggregate demand. Governments engage in monetary and fiscal policies in an effort to stabilize the economy to correct for these market failures to ensure full employment. Governments also seek to avoid excessive and erratic inflation that can erode purchasing power and can impair the functioning of financial markets. Although the stabilization activities of government do not absorb significant amounts of economic resources, they do represent an important complement to the efficient functioning of markets. Economic stabilization programs are more complex but worth implementing, although modern public finance concentrates on the microeconomic aspects of government activity and finance rather than the macroeconomic aspects. EQUITY VERSUS EFFICIENCY.  Efficiency is not the only criterion used to evaluate resource allocation. Many citizens argue that outcomes should also be evaluated in terms of equity; that is, in terms of the perceived fairness of an outcome. The problem involved with applying criteria of equity is that, persons differ in their ideas about fairness. Economists usually confine their analyses of questions of equity to determinations of the impact of alternative policies on the distribution of well-being among citizens. For example, many people are concerned about the impact of government policies on such groups as the poor, the aged, or children and women. Positive economic analysis of the outcomes of market and political interaction is useful in providing information about the effects of policies on income distribution. In the field of public finance for example, analysts usually try to determine the effects of government actions on both resource allocation and the distribution of well-being, thus providing useful information that citizens can use to judge the equity on alternative policies in terms of their own notions of fairness. A perfectly competitive market system can be given high marks because it is capable of achieving efficiency. The efficient outcome in a market system is a point on the utility-possibility curve. In a market system, each person’s money income will depend on the amount of productive resources owned and the returns obtained from selling productive services to others in markets. The distribution of income will determine the willingness and ability to pay for various goods and services that the economy can produce with available resources and technology. Many critics of the market system argue that it cannot be given high marks on the basis of equity criteria. They complain that many participants in the system cannot satisfy their most basic needs because low incomes provide them with little capacity to pay for market goods and services. Poverty in the midst of wealth is regarded as inequitable by many people. The market system caters to those with the ability to pay, which depends on earnings. This, in employable only at low wages. In addition, they usually own no land or capital, meaning that their non-labor income is also low. Critics of the market system also argue that these poor people should receive transfers financed by taxes on more fortunate members of society. The incomes of the poor, and therefore their level of annual well-being, would be kept from falling below minimum standards. This, however, creates a dilemma. Often, as is shown throughout by imposition of taxes and subsidies that is used to alter the distribution of income which may also, distort incentives to produce in ways that prevent achievement of efficiency. Policy makers are confronted with the inevitable conflict between the quests for both efficiency and equity. This is the most difficult challenge in this part of the cosmos.

Dr Moyi Harry Ruben 211 912 940 728

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