Title Chapter 7 ( Unit 2 ).pdf ✅

Introduction ▪ The market is an environment where buyers and sellers transact or exchange goods and services. ▪ The general belief is that since rational individuals act to maximise self interest, a perfectly working market system is, by default, efficient and will effectively allocate scarce economic resources in the best possible manner. In other words, in a well functioning market, prices provide the accurate signals to producers and consumers and the right quantity of whatever consumers choose to consume will be produced and supplied at the right price. ▪ However, this is not always true. Under certain circumstances, ‘market failure’ occurs, i.e. the market fails to allocate resources efficiently and therefore, market outcomes become inefficient. Market Failure ▪ The inefficient allocation of resources in an economy is described as market failure. The term “market failure” does not mean the market is not working at all, it only means that the market does not function in the way that it should. Market failure is a situation in which the free market leads to misallocation of society's scarce resources in the sense that there is either overproduction or underproduction of particular goods and services leading to a less than optimal outcome. UNIT – 2: MARKET FAILURE/ GOVERNMENT INTERVENTION TO CORRECT MARKET FAILURE
Types of Market Failure Complete Market Failure This is a case of "missing markets" and occurs when the market does not supply products at all despite the fact that such products and services are wanted by people. E.g. Pure public goods. Partial Market Failure Market does actually function, but it produces either the wrong quantity of a product or at the wrong price. This results in loss of economic welfare. Why do Markets Fail? ▪ Perfectly competitive markets will generate outcomes in which the economy’s resources are allocated to their ‘highest valued uses’ and no one person can be made better off without making at least another person worse off. But we know that conditions such as large number of small firms, perfect knowledge, homogenous products etc. are not generally present in most markets. There are four major reasons for market failure. They are: • Market power, • Externalities, • Public goods, and • Incomplete information
Market Power ▪ Market power or monopoly power is the ability of a firm to profitably raise the market price of a good or service over its marginal cost. Firms that have market power are price makers and therefore, can charge a price that gives them positive economic profits. ▪ Excessive market power causes the single producer or a small number of producers to restrict output (i.e produce and sell less output than would be produced in a competitive market) and charge price higher than what would prevail under perfect competition. ▪ These profits are not achieved due to operating efficiency, but due to market power and dominance. Thus, market fails to produce the right quantity of goods and services at the right price Externalities ▪ When a consumption or production activity has an indirect effect (either positive or negative) on consumption or production activities of others and such effects are not reflected directly in market prices, we call it an externality. ▪ Externalities are costs (negative externalities) or benefits (positive externalities), which are not reflected in free market prices. They are called externalities because they are “external” to the market. ▪ Externalities are also referred to as 'spillover effects', 'neighbourhood effects' 'third- party effects' or 'side-effects', as the originator of the externality imposes costs or benefits on others who are not responsible for initiating the effect. ▪ Since it occurs outside the price mechanism, it has not been compensated for, or in other words it is uninternalized or the cost (benefit) of it is not borne (paid) by the parties. -MCN , Nonprofit - Mopoly P > MC D7S - - -
Externatio Production - - Consumption Receiver Receiver Prod Cons . Prod Cons . Positive Negative Positive Negative Cost Price Demand& -> Overprod