16: Market Failure

As consumers, we want perfect competition to maximize consumer surplus.

Businesses want monopoly to maximize profits.

Function of Government

  • monopoly on violence.

  • Citizens can safely carry out their ordinary economic and social lives. If not, citizens cannot carry out their economic and social lives.

  • The government subsequently keeps this market in check.

Continuum:

  • 100%: command economy

  • 0%: free market.

Case for Free Markets

  • Automatic correlation for the actions of decentralized decision makers

  • Provides a stimulus for innovation and a general rising in material living standards → improve to the point its non-substitutable.

  • Permits a decentralization of economic power based on what we want.

Formal defence: if all markets were perfectly competitive, and if governments allowed all prices to be determined by demand and supply, then resources would be allocated in an optimal manner. That is, price would equal marginal cost for all products and thus the economy would be allocatively efficient.

  • Allocative efficiency only occurs in one spot: where demand equals supply.

Market Failures

  • Free market does not achieve allocative efficiency.

  • Market power

  • Externalities: third party effects on parties not directly involved in the production or use of a commodity. e.g. toxic pollution in the river — affects somebody. Second hand smoke.

  • Public goods: good/services that can simultaneously provide benefits to a large group of people (National Defence); Wagner Group example.

  • Information asymmetries: one party has more or better information about the transaction than the other party. (moral hazard and adverse selection); e.g. the terms of service for insurance.

    • Moral hazard: more information than the other party

    • Adverse selection: discrimination based on stats, car insurance etc.

Government Intervention

  • Income distribution: welfare

  • Public provision: police/fire

  • Protection of individuals: child labour, min. wage

  • Social responsibility: jury duty/military service

  • Paternalism: protect individuals from ignorance

  • Economic growth: micro/macro issues

Tools: redistribution/provision/regulation/incentives