Market failure Assignment Help

What is market failure?

Market failure, basically is a situation where in there develops an inverse relationship between the demand and supply of commodities produced. In simple words when the demand for a good or service is higher than the supply of the relevant good or service in the market and the demand is not being met then the market fails or market failure arises. In this situation, the market is not able to supply with enough goods and services, but the demand increases regularly.

Market failure Assignment Help

Market failure often leads to a chaos and dissatisfaction among the masse. The result of market failure is the immense surge in prices making it hard for the general population to afford the commodities. Market failure is followed by financial imbalance in the economy and widens the financial gap more than it already is.

What are the reasons for market failure?

The main reason for market failure is the inefficiency in the allocation of goods and services. Markets are hard to predict because of their huge dimensions made up of immense number of people. The people change their taste and preferences each day making it hard to predict the demand and so regulating supply becomes a tedious task. Therefore, most markets are not successful and require forms of intervention. Following are the several reasons for market failure.

1. Positive and negative externalities: externalities are the side effects of producing and consuming certain goods and can be both harmful as well as beneficial and are borne by people who are not directly related to exchanges that take place in the market. Externalities having negative impacts on the well- being of the third parties are called external costs and externalities having positive impacts on the well - being on people are called external benefits or 'spillovers' when they spill over into other people's lives.

Positive externalities refer to the beneficial outcomes of consumption of goods and services. For example, sports are taught to students or players so that they can play and build a future in it for themselves. But it indirectly affects the country as it builds a proud moment for the nation. It also helps in building awareness about the benefits of sports.

Negative externalities refer to the harmful outcomes of consumption of goods and services. For example, people smoking cigarettes affects them and also the ones surrounding them. This leads to negative externalities.

2. Environmental concerns: environmental concerns include concerns such as pollution, global warming or extreme cold indirectly affecting the demand and supply of goods and services.

3. Deficiency for demand of public goods: there are certain public commodities whose cost of production remains the same no matter how much the amount of customers increase. For example the cost of installing a street lamp remains same no matter how many people use it not incurring any cost. Therefore we see that most of the times people exploit these resources and use them lavishly. This problem of people using things without paying the cost of benefit is called free rider problem. This leads to deficiency in the demand of the public goods.

4. Underutilization of merit goods: the market provides with a vast type of commodities out of which certain goods have adequate supply but due to their underutilization the demand for such goods remain low or we can say that there is excess supply. Example: education, healthcare, sports centers, etc.

5. Overutilization of negative commodities: goods such as cigarettes, alcohol, drugs, etc. Are being overused. These things destroy the city, country and people and thus lead to market failure.

6. Wrong usage of monopoly power: uncontrolled market leads the business industry to control the output and increase the prices so as to maximize the profit.

7. Markets become unstable: market is an unstable. People are dynamic beings so with the changing trends people change their tastes and preferences and start to demand a certain commodity in more numbers than another product previously used by them. The basic focus of a business empire should be consumer satisfaction and innovation and strive towards capturing the larger market. But as we see that the taste and preferences of the masses change quickly the product might not be available in the market at a larger scale and so due to increase in demand and decrease in supply there will be market failure due to exceptionally high prices.

8. Income gap: market failure can occur when there is excess supply of a particular commodity and everyone wants it but due to limitations of income not everyone can afford it. Therefore demand decreases and market failure starts to take shape in the form of higher prices and increasing income gap among the higher and the lower income brackets.

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Now to solve the problem the government generally uses two methods:

  1. Price controls
  2. Laws and regulation enforcement

Price controls are restrictions levied by the government on the prices of many commodities or services with the intend to maintain the affordability of necessities like staple food and goods, curb extreme hikes in prices while shortages and slowing the rate of inflation or with the intend to provide a minimum income to the providers of specific goods and services.

Price ceiling mainly exist on staple foods like sugar, wheat, rice, salt, etc in developing countries. It also exists on house rents, fuel, etc.

For price ceiling to be binding, it must be set below the equilibrium price. When the maximum price is set below the equilibrium price, there will be excess demand or the storage of supply. Actual quantity exchanged will fall below its equilibrium level.

Price floor is a government imposed price control which puts limits on how low the price of a commodity can be charged for a product. A price floor should be higher than the equilibrium price for it to be effective.

The most common form of price floor is imposed as the minimum wage rule which implies the minimum price that can be paid for labor. Price floors are often implemented on agricultural produce in order to protect farmers.

If price floor is set above free-market equilibrium price, then as a result there will be a surplus of the commodity in the market. This price floor will lead to a more inefficient market too and also cause a decreased total economic surplus.

Legislation and law enforcement: to reduce market failure the government needs to make strict legislations and laws and enforce them effectively to reduce exploitation of the masses as well as the producers depending on the cases.

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