Market Failure

Market failure has become an increasingly important topic for students.There is a clear economic case for government intervention in markets where some form of market failure is taking place. Government can justify this by saying that intervention is in the public interest. Basically market failure occurs when markets do not bring about economic efficiency.

EXAMPLES OF POTENTIAL MARKET FAILURE Public Goods not provided by the free market because of their two main characteristics Non-excludability where it is not possible to provide a good or service to one person without it thereby being available for others to enjoy Non-rivalry where the consumption of a good or service by one person will not prevent others from enjoying it Examples: Street lighting / Lighthouse Protection, Police services, Air defence systems, Roads / motorways, Terrestrial television, Flood defence systems, Public parks & beaches

Because of their nature the private sector is unlikely to be willing and able to provide public goods. The government therefore provides them for collective consumption and finances them through general taxation.

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 & services. Consumption of merit goods is thought to generate positive externality effects where the social benefit from consumption exceeds the private benefit. Examples: Health services, Education, Work Training, Public Libraries, Citizen's Advice, Inoculations

Monopoly Few modern markets meet the stringent conditions required for a perfectly competitive market. The existence of monopoly power is often thought to create the potential for market failure and a need for intervention to correct for some of the welfare consequences of monopoly power.

Externalities Any exam question on market failure must make some reference to externalities. What are the potential market failures arising from externalities?

Inequality Market failure can also be caused by the existence of inequality throughout the economy. Wide differences in income and wealth between different groups within our economy leads to a wide gap in living standards between affluent households and those experiencing poverty. Society may come to the view that too much inequality is unacceptable or undesirable. Note here that value judgements come into play whenever we discuss the distribution of income and wealth in society. The government may decide to intervene to reduce inequality through changes to the tax and benefits system and also specific policies such as the national minimum wage

Government intervention may seek to correct for the distortions created by market failure and to improve the efficiency in the way that markets operate Pollution taxes to correct for externalities Taxation of monopoly profits (the Windfall Tax) Regulation of oligopolies/cartel behaviour Direct provision of public goods (defence) Policies to introduce competition into markets (de- regulation) Price controls for the recently privatised utilities