The market is based on a certain balance between demand and supply; it promotes competition if left without interference witch promotes choice, quality, and lower prices. A situation in which the quantity of a product demanded equals the quantity supplied, leads to no pressure to change the price and its called market equilibrium.. There will be reduction in equilibrium price if the number of firms increases because of increased supply
markets fail to do an efficient job under many defined circumstances, common property resources, public goods, harmful externalities, asymmetric information, missing markets, monopoly power are some of the circumstances. In order to improve market efficiency government intervene putting into action policies that could do this job under ideal circumstances.
Markets work in an ideal way when products are excludable and rivalrous.
Rivalrous goods are like an apple, it is consumed only once. Non-rivalrous ones are those not affected by the number of consumers such as art galleries.
A product or a service is called excludable when consumers are prevented from obtaining it, cars for example. A good is called non-excludable if once produced no one can stop anyone from consuming it, and that is the case of common lands.
Common property: common property is the first reason for market failure because all individuals can exploit them, in most cases The tendency of overexploiting commonly held property to the extent of destruction, is called ‘the tragedy of the commons’. The resources of common properties should not be overused; in this case government intervention is needed for the general good by enforcing laws and regulations or by privatization; nowadays fishing in the Mediterranean is limited by catch quotas, minimum mesh size… Enforced by the European Union; in another side common properties are been privatized insuring certain efficiency of wood gathering rather than destroying them, however previous users can’t have the resource anymore and that causes an equity problem.
Public goods: They are the second reason of market failure. Goods that are neither excludable nor revalrous are called public goods, this is the case of national defense: an army protects all citizens equally whether or not a particular individual pays taxes to support it. The practical problem is based on whether people are willing to pay for a certain public good; Governments provide the public goods and cover their expense from tax revenues (so that there will be no ‘free rider problem’).
Externalities: externalities are cost or benefits for a certain transaction that affects other people than the producers and consumers of the transaction, pollution and adverse health effects are examples of externalities. Externalities create a divergence between the private benefits and costs of economic activity and the social benefits and costs, social costs are the costs incurred by the whole society. Social benefits are the benefits to the whole society. When social marginal cost equals social marginal benefit society’s resources are optimally allocated. Government control pollution either by direct regulation or emissions taxes; the first one is common method of environmental regulation for example the obligation of emissions standards for new cars and over three years aged ones when taking the annual MOT test… And the second one adopts emissions taxes when possible to measure accurately because in many cases there are no effective measuring devices.
Asymmetric information: if everyone is well informed than the markets will work best, lack of relevant information can affect people decisions; in fact it can lead to a market failure. Rules requiring a correct description to products and prices are meant to improve the efficiency of people choices; however error results could be too drastic allowing consumers to get experiences of reliable and unreliable products. Safety standards are also sated by the governments in work places; in addition we have safety standards if there is a risk of microbes in certain foods. Also work standards are important for both employees and companies. In some situations authorities hardly remove the differences in information existing for buyers and sellers. The superior knowledge can be used to influent the transaction nature and that is the case of doctor because typically they know much more than their client.
Missing markets: According to American economists Arrow and Debreu who studied necessary conditions for optimality in resource allocation, a separate market must exist in which each good and service can be traded to the point where the marginal benefit equals the marginal cost. Missing markets are one of the causes of market failure. It might be less obvious then other cases but it is equally important. Missing markets involves risks; for example a citizen can insure his car against accidents, the probability of him having an accident is usually independent of the probability of other citizen having a car accident; however farmers, in most cases, can t insure their crop against natural disasters because buy then the insurance company has to pay all farmers in the same time and that is impossible because insurance companies survives buy pulling independent risks and that is not the case of farmers because the same event affect all client in a similar way.
Futures events are another set of missing markets, future market of most product are missing because no one knows the specifications of future models.
Monopoly power and public policy toward it: A non-competitive practice is called monopoly; the formation market power is contributed by cartels and price fixing. The competition policy work on encouraging competition and discouraging monopoly practices by law regulations and other instruments. Rules that companies must follow and prices that they should charge are among economic regulations toward monopolies. Governments adopt competition policies and regulate economic laws, for the purpose of controlling the market power, market structure in addition to its behavior are also affected. Authorities intervene and use a number of policies (as mentioned before), here is some of it:
Direct control of natural monopolies; this kind of monopolies is established when an industry is so dominant that there is room for only one firm to operate at the minimum efficient scale, in this case government can either operate the firm and control the price, or it can regulate the private firm’s behaviors. Noticing that technological advance can destroy natural monopolies, new competitive products will enter the market; however prices can be pushed so far down that incentive to invest in technological innovations would be very low.
Direct control of oligopolies; enforcing prices and executing behaviors for the public interests are government’s responsibilities. In contrary of politics adopted between the end of World War II and 1980 s, the last twenty years have witnessed privatization and some deregulation to increase competition, encourage innovations, not mentioning that in most cases private firms perform better then national one’s, and appearance of globalization and the information and communication revolution. However authorities intervention is still needed because externalities and other market failures make it inefficient to leave the free market decide resource allocation. Privatization caused lower prices and higher stock market values.
Intervention to keep firms competing; encouraging competition in the market is highly important: Firms are usually prevented from merging unnecessarily, from being involved in anti-competitive practices, and from setting monopoly prices. Globalization, GATT and World Trade Organization are the three main factors that encouraged competition and helped the reduction of worldwide tariffs. However intervention is still needed, even though less then before, keeping competition between firms;
Three important institutions for enforcing competition policy: Restrictive Practices Court (RPC), Office of Fair Trading (OFT), Monopolies and Mergers Commission (MMC).
As ma mater of conclusion the market is based on the demand and supply rule, and as mentioned before various factors can lead to inefficiencies or failure in the market, haw ever in some cases government interference is necessary to obtain the market stability but in the same time governments can fail same way that markets fails.
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