Market failure and what government can do Essay

Market failure and what government can do - Essay Example Market failure is the failure of the market to yield efficient outcomes. Elaborating further, Stiglitz said that there are six situations in which markets are not efficient and these are referred to as market failures that provide a rationale for government activity.The six conditions in which markets fail to lead to efficient outcomes are those in which competition fails, situation in which public goods are involved, market situations in which there are externalities, situations in which markets are incomplete, situations in which information is imperfect, and situations in which there are macroeconomic disturbances (Stiglitz 2000, p. 77-85). For markets to lead to efficiency, markets must be perfectly competitive (Stiglitz 2000, p. 77). This means that there are no constraints for competition to prevail in the market. Examples of situations in which competition does not prevail are those involving monopolies and oligopolies. Monopolies are market situations in which there is only o ne seller while oligopolies are market situations in which there are only few sellers. Both monopolies and oligopolies can charge consumers prices that are higher than those which can prevail in perfectly competitive market settings.1 Public goods are those whose consumption is non-rival and non-excludable as opposed to private goods whose consumption are rival and excludable. Non-rival means consuming the good will not deprive others of the good. Road services or city lighting services, for example, are goods or services that are not deprived to others when an individual consume or use the good or service. They are also non-excludable in consumption because it is costly, feasible, or impractical to exclude others from consuming or using the good or service. In the literature of economics, economists usually use the term pure private goods and pure public goods to refer to pure cases but they recognize that there are goods in-between or public goods that have private goods character istics as well as private goods that have public goods characteristics. Sometimes, these goods are also referred to as mixed goods.2 Externalities refer to effects on third parties other than the consumer or producer of the product. For example, consumer may use gasoline but parties other than the producer or consumer of the product receive the pollution. Externalities can be positive or something good such as the benefits to the environments of a certain car that does not use fossil fuel or it can be negative like that in car that pollutes the environment. Economic literature holds that when markets are competitive, prices almost equals costs and goods are produced at costs. However, because of externalities, markets can lead to situations in which goods may be overproduced or under-produced, depending on their effects to society.3 Incomplete markets refer to situations in which although the cost of providing the good is less than what consumers are willing to pay, the good is not produced just the same (Stiglitz 2000, p. 81). The situation of incomplete markets implies that there are things missing in the market because otherwise the good or service would have been produced if there is nothing that is missing in the market (Stiglitz 2000, p. 81). Incomplete markets can emerge when complementary services are lacking, transaction costs are too high, and the like (Stiglitz 2000, p. 81-82). It is possible that incomplete markets are one of the least studied market situation in the academic literature. The literature on the topic does not seem many. Information asymmetry or imperfection in information is also another cause for market failure to happen. For example, borrowers can know their risks as borrowers but lenders may not know the risks of lending to the borrowers. In another scenario, investors want to invest but they do not know the potential returns and possible risks in investments and, thus, they are constrained from investing. Finally, many scholars i nterpret