Market failure and how government can attempt to correct it Market failure is a situation in which the free market fails to allocate resources effectively, causing a situation where the quantity demanded by the consumer is unequal to the quantity supplied by the supplier. Leotard (1987) argues in the textbook Environmental Economics in Theory and Practice that “the best way to understand market failure is to first understand market success” (Hanley, et al. 2007, p. 44) My definition of market success would be an open market whereby the quantity supplied meets the quantity manned, with no overcompensation of goods that have a long-term cost to society and provision in place for basic essentials to be supplied to society In the correct proportion. There are many reasons why market failure can occur, and it is not a rare occurrence.
This appears to be backed up in statements by Nelson (1987) and Dolman (1 979), quoted in the textbook Economic Efficiency in Law and Economics: “A fundamental problem with the concept of market failure, as economists occasionally recognizes, is that it describes a situation that exists everywhere” (Zero, 2002, p. 168). I will look at some of he reasons why market failure occurs, with examples, and look at forms of government intervention to try’ and correct it. Will then look at some instances of reported market failure within the London property market and how government has intervened, as well as assessing the success of the intervention.
Public goods Public goods, as outlined by McConnell and Bruce (1999, up. 87,88), are indivisible to individual buyers and it would be impossible to exclude individuals from benefiting once these goods/services come into existence. An example of such public goods would be a lighthouse on a treacherous coast. It would be economically justified, as the benefit of fewer shipwrecks would far exceed its cost. The benefits to each individual, however, would not be great enough to justify them paying an individual fee.
Furthermore, once in operation the light generated would be a guide to all ships and there would be no way to exclude any non-purchasers. The problem of people benefiting without contributing to cost is known as ‘the free-rider problem’. For these reasons private enterprises have no economic incentive to supply such goods/services as they cannot be effectively priced and sold to create an economic profit. Market failure therefore occurs as there is a service which could yield substantial benefits, yet the market allocates no resources to it.
Some other examples of public goods would be street lighting and national defense (army). The way that government intervenes to correct the market failure in the instance Of public goods is for the State to provide such services and aim to recoup the cost in the form of taxes. Merit goods As Heathery and Otter outlined (201 1, p. 42), a merit good is something that arguably all people should have access to, regardless of ability to pay. If left to the free market, people may be priced out of the market and denied access to such essentials as education and healthcare.
It is therefore often expected that the state should intervene and provide these things so that everybody has access to them. Government can be keen to intervene as the consumption of merit goods will often lead to positive externalities. (See below for details on externalities. ) I am of the opinion that consumers generally take a purely selfish view and therefore do not take into account the greater benefits of merit goods, which therefore leads to underestimation. In some ways see merit goods to be quite similar to public goods, and government intervention is often the same, I. The state provides these services. In some instances, however, merit goods can be supplied by private businesses, such as private hospitals and private schools. If left solely to the private sector, however, a large sector of the population would be unable to consume owing to financial constraints. Private enterprises therefore Often run hand in hand with the state providing merit goods such as education and healthcare. Government funding is also often made available to encourage nonusers to pay for merit goods at a subsided price via the private sector, I. E prescriptions and NASH dentists.
The other difference, as described very well in the textbook Organizations and The Business Environment (Campbell & Craig, 2005) is that merit goods tend to only be taken advantage of as and when needed, I. E the health service we only use when ill, or education which is used when we are young or when we wish to further our development later in life. Public goods such as street lighting are used by everybody on a regular basis, whether deliberately or otherwise. Demerit goods Demerit goods are generally considered harmful in some way and have external costs which are not generally taken into account when purchased.
The market failure in this instance would therefore be overproduction/ consumption at a cost to society. Common examples of demerit goods would be cigarettes and alcohol which, aside from the cost to society I. E. Antisocial behavior, passive smoking etc. , also have a cost to the consumer’s own health. Government intervenes in such cases to prevent overproduction/ consumption by putting laws in place to help reduce consumption I. . Restrictions on times when retail outlets can sell alcohol and age limits.
It also often levies additional tax on demerit items which a) helps contribute towards some of the social cost and b) may slightly deter consumption owing to the price. Externalities Market prices reflect the individual cost to the business and the benefit gained from the product (Heathery & Otter, 2011, p. 42). On many occasions, however, the economic activity may have a social benefit or benefit to a third party such as education or healthcare, as described earlier. Clearly a healthy ND well-educated population will produce a far more productive workforce and demand less spending by the state in terms of welfare and healthcare.
Market failure occurs as the external benefits are undervalued by the market and the goods end up underclassmen or underreported. Believe that the most practical way for government to intervene in this instance is to provide either an incentive or funding to assist in production to correct the market failure. This sentiment appears to be corroborated in the following statement: “While typically the remedy for market failure due to public goods is for the public sector to provide the good, the remedy for externalities is often to provide incentives to the private sector to produce the correct amount” (Wilding & Bawdy, 1 984, p. 1 A prime example of an incentive being provided would be the subsidizing of university fees or government funding available to businesses to invest in training. In some cases, particularly with merit goods, the state intervenes and actually provides the good. In contrast to a positive externalities, a negative externalities would be a social cost or cost incurred by a third party I. E. Elution caused by a factory or the cost to the state in healthcare from illnesses caused by cigarettes and alcohol.
Demerit goods would generally have negative externalities; however, it is important to note that not all goods with negative externalities are demerit. A negative externalities could be the social cost of pollution from a factory, for instance. Market failure in the case of negative externalities would generally be overcompensation due to consumers failing to take into account the external costs to third parties. The most common form of government intervention in hose cases is taxation, to ensure that consumers are contributing to the social cost, I. Tax on cigarettes and alcohol or congestion charge. Monopolies Monopolies can occur when a single business or a small group of businesses controls a large market share. Market failure is quite likely due to these businesses having the ability to drive up market prices, potentially leaving the product priced higher than it would be in a fair competitive market and leaving the consumer worse off. Equally a business with a large market share also has the ability to demand lower prices from the supplier at a cost to the applier.
In addition to this, when a business has an overly large market share the lack of competition can lead to a drop in funds and effort invested into research and improved management, leading to a loss of product efficiency. A 201 1 news report identifies a case where five businesses account for 90% Of the cement market, 75% of aggregates and 68% of ready-mix concrete. There were concerns that a lack of competition had driven up building costs, resulting in the government overpaying for schools, hospitals and roads (Riley, 2012).
Government intervention to prevent monopolies causing market allure is very common, usually in the form of regulation. There are various regulatory bodies that will look closely at possible cases of market monopoly such as the Competition Commission, which investigates mergers and also investigates markets with competition concerns such as supermarkets, and the Office of Fair Trading, which reports on various anti-competitive practices. Market failure and the London housing market A report by GAL Economics into market failure in the London housing market (2003) outlines some key areas of market failure.
One of the biggest problems s a serious unresponsiveness of supply to growth in demand. Demand for houses then drives up prices, leaving an even bigger shortage of options for those on a lower income. Furthermore the report suggests that overall supply of housing in London has been in decline since the 1 sass, with no corresponding decrease in demand. For decades the council house building programmer compensated for this; the fall in levels of construction Of social housing more recently has therefore hit the affordable end of the market hardest.
Government intervention in the housing market by building and offering social housing is to guarantee a certain standard of home for every family ATA price within their means. My own interpretation of this is that it quite correctly sees affordable housing as a merit good. It is certainly debatable, however, how successful it has been in achieving this objective. Another form of government intervention in the housing market is planning regulations; these are put in place by the state to respond to changes in demand, monitor density controls and maintain planning and design standards.
Evans (1 987, quoted in GAL Economics, 2003) argued, however, hat the planning system, through the regulation of supply of usable land, reduces the extent to which house builders can respond to changes in demand and actually pushes up prices in the long run. He provides evidence showing land and house price inflation outstripping increases in household incomes and the retail price index throughout the asses and ass. During these same decades, house builders were spending a large amount of money pursuing planning permissions and maintaining land banks.
These sums were then passed on to consumers via higher land and house prices. If Vans’s hero is to be believed, this could be described as a clear case of ‘government failure’, which is the term used to describe a situation when government intervention in the economy to correct market failure actually exacerbates the problem. The GAL report, however, cites Gringo’s (1986) as arguing that the planning system cannot push up prices in either land or the housing market. He stated that the supply of new-build housing is only a small proportion of the housing market which is dominated by second-hand homes.
Us m Mary Market failure appears frequently and will continue to do so. There are many contrasting views on the effects of market failure and the best way to remedy them. It is my opinion that for every argument against a solution there would be also be many ideas and theories supporting the same idea, as shown in the opinions on planning regulations. I wonder whether state provision of public goods is effectively forcing a monopoly, leading to questions about the efficiency of organizations such as the NASH. Others would have many theories about why this was not the case.
In my opinion, incentives private genuineness to provide merit goods is a model that works very well but there will be people who I am sure would come up with valid reasons why that system has flaws. Market failure will always exist, and a government solution that pleases everybody is virtually impossible.