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Market Failures

As productive and as efficient as our modern economy is we cannot meet all of our needs and all of our wants. This being the case, an certainly no one would expect perfection, there is clearly some failure on the part of the market to provide these goods and services. While the term failure may be a tad harsh, it is the essence of what has occurred... a market failure.

Market failure - The situation that exists when the market fails to function properly. Market failure occurs when the following condition exist:

  • When adequate competition does not exist. In an age where mergers are all too common, the result has been an increase in larger and fewer firms in many industries. In extreme cases, this results in a monopoly. The greatest threat that a monopoly poses is that it denies consumers the benefit of choice and competition. Because a monopoly occupies the top spot in its market, it can use its position to impede competition and restrict production. Thus in the end there are artificial shortages and higher prices. Inadequate competition may also enable a firm to influence politics by means of economic strength. In the past there have been executives who furthered the political careers of those closest to them. Though it is not necessary for a business to be a monopoly in order to influence politics, it certainly helps. A large corporation may simply want tax brakes on a state or local level. If the government refuses, then the plant may threaten to moves its facilities elsewhere. Because the government does not want an economic loss to its area, it may acquiesce to the demands of the corporation. In order to efficiently allocate resources, consumers, business people, and government officials must have adequate information about market conditions. Some of which is easy to obtain like sales prices or want ads. Yet there is a little more difficulty in ascertaining information about a companies earnings and dividends.
  • Buyers and sellers are not well informed. Without information uneducated decision are made. This leads to mistakes and thus, market failure.
  • Resources are not free to move from one industry to another. This is known as resource immobility. Resource immobility is a difficult problem in any economy. The efficient allocation of resources requires that land, labor, entrepreneurs, and capital be free to move to markets where returns are the highest. But there are times when a business that is located in a certain community decides to up and leave, leaving hundreds unemployed. The consequence of the move is a reason that may hamper the corporation from taking its business elsewhere. Resource mobility is considered ideal in the competitive market economy, but is actually much more difficult to accomplish. When resources are immobile, markets don't function, as they should.
  • Prices do not reasonably reflect the costs of production. This represents a problem because then wealth is being redistributed unfairly and prices are too high.


Externality - an economic side effect that affects an uninvolved third party. These are also examples of market failures. There are two types of externalities:

  • Negative externality- harmful side effect that affects an uninvolved third party. In most events, it constitutes external cost.
  • Positive externality- beneficial side effect that affects an uninvolved third party.

    An externality, by definition, is an economic side effect that either benefits or harms a party not directly involved in the activity. A negative externality is an action that harms a third party resulting in external cost. An example of this would be the construction going on on the LIE. Because the roadway is being widened, trees along side have been taken down, thus exposing the once secluded service road and the homes that are alongside it. This construction has annoyed drivers, who have to put up with the mess and homeowners as well. A positive externality is if the economic action benefits a third party. Such an example can be drawn from the previously mentioned one. The construction on the LIE may cause traffic tie-ups, but local businesses may benefit from the traffic, which detours by their shops, and the workers who may require services from one of the businesses.

Public Goods

Public goods are those goods and services provided by the government because a market failure has occurred and the market has not provided them. Sometimes it is in our benefit to not allow for a market provision. In the case of police, national defense and public education it can be argued that private provision of these services would be less desirable for a variety of reasons.

Public goods are economic products that are consumed collectively, like highways, sanitation, schools, national defense, police and fire protection.

All members of society should theoretically benefit from the provision of public goods but the reality is that some need them more then others. For example the wealthy do not need welfare and the elderly still pay for school taxes. This leads to the inevitable argument about paying for public goods.... taxes!

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