In connection to the above statement, examine why markets sometimes fail to allocate resources efficiently, how government policies can potentially improve the market’s allocation, and what kinds of policies are likely to work best. Your answer has to be supported with suitable current examples and evidences.
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In the market, there are many different variables that can affect the market condition. The government cannot make sure that can maintain in good conditions. There might switch to in a bad situation, for examples, market failure, recession and inflation. The economist Adam Smith made an observation in all of economics in his 1776 book. Adam Smith’s 1776 explained scientifically the most important meaning of invisible hand. According to the Principle Government can sometimes improve market outcomes. As arise these problems, government interfere the economy by establishing policies to undertake those matters. We are going to examine the reason of the market failure and how the government policies improve the market’s allocation. In addition, state out the suitable policies working best.
Market efficiency is the property of society maximizes the benefits it achieves from the use of its scarce resources. When the production is efficient, the economy will obtain all it can from the scarce resources that is available and there is no way to produce more than a good without producing less of other goods. Market failure is a circumstance which a market will overlook its own fails to allocate resources efficiently. Thus, there are several possibilities that can cause market failure such as externalities, market power and public goods as well as incomplete information.
Externalities are based on the impact of an individual action on the well-being of a bystander. Hence, they enforced people other than the consumers and producers of a good or service. Therefore, externalities are also called spillover effects. People other than consumers and producers who are affected by these side-effects of market exchanges are called third parties. Externalities may be either negative or positive; that is, they may be disadvantageous or beneficial to the third party. For instance, we are off to bed and our neighbour is having a dancing party with high volume rock music. The action of our neighbour is imposing negative externality on us and the third parties who are trying to sleep. As it results from annoyance of our neighbour’s playing the music, this is an example of a consumption externality. (Diagram 1) However, externalities are also an external positive externality too; by the way, negative externalities are only caused the market failure. On the other hand, the production externality are generated, for examples, atmospheric pollution from factories and the long-term environmental damage caused by depletion of natural resources. The factories expel harmful gases such as CFC, carbon monoxides, hydrocarbons from the chimney, that causes bystander health. The externality is considered to be an important factor contributing to economic growth. (Diagram 2)
Market power is also one of the reasons of causing market failure. Market power, which refers to a firm can influence the price by exercising control over its demand, and supply. It does not exist when there is perfect competition, but it does when there is monopoly, cartels, or monopolistic competition. The invisible hand of the market leads to an allocation of resources that makes total surplus larger as it can be. As monopolies leads to an allocation of resources different from that in a competitive market, the monopolists keep prices and profits high by using its market power to restrict output below the socially efficient quantity. The monopolists choose the profit-maximizing quantity of output at the intersection of the marginal-cost curve and the marginal-revenue curve. It is not at the lowest point of the average total cost curve, intend that the available resources are not fully use and so will fail to produce an efficient allocation of resources. The inefficiency of monopoly also can be measured with a deadweight loss triangle area between the demand curve and the marginal-cost curve, which reflects the total surplus loss and the costs of the monopoly producer. Buyers who have willingness to pay less than the price will not buy it. It is the reduction in economic well-being that results from the monopoly’s use of its market power.
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If there is a natural monopoly, it does not necessarily follow that there is substantial economic inefficiency. First, if entry into the industry is easy, the threat of potential competition may limit the extent to which an incumbent monopolist can restrict output (and raise prices). Second a monopolist may choose to use a pricing policy, involving fixed charges and a low unit price, which can both increase profits and benefits consumers. Third, if there are a number of possible suppliers of a monopoly service, competitive bidding for the right to be the monopolist can be used to lower the supply price and increase economic efficiency. Similarly, an alternative to the regulation of the electric power industry is for communities to own the local distribution system and bargain with power companies for the supply of electricity.
Other than those reasons above, the another reason which will cause market failure happen is public goods. Public goods can define as goods that will not reduce the availability of it for consumption by others after people make consumption. By the way, once public goods are available, no one can be withheld to consumpt them for free. Public goods are normally provided by the government example like protection provided by police, fire departments, and the military. Public goods provide the free rider problem, which means the private organizations cannot get all the benefits of the public goods which they have produced, there would be no incentive for them to voluntarily provide public goods; consumers can take advantage of public goods without contributing sufficiently to their creation. This situation can produce inefficiency and a resulting market failure.