First of all it is necessary to give the definition to the term market failure. Market failure is “something that is inherent to the market that causes the market equilibrium allocation to be inefficient” (Morey, 2015). According to Pettinger, market failures “occurs when there is an inefficient allocation of resources in a free market” (Pettinger, 2015). Both of these definitions underline that market failure is the situation opposite the ideal market. Taking into the consideration, that we live in times when ideal market do not exist in reality and is replaced by tough economic rules and high competition.
There exist 10 main types of market failures:
Externalities – are consequences that are produced during economic activity of third parties.
Positive – when these consequences bring benefits to third parties. For example, the process of recycling.
Negative – when these consequences bring harm to third parties. The most vivid example is all kinds of pollution.
Merit goods – “Goods or services (such as education and vaccination) provided free for the benefit of the entire society by a government, because they would be under-provided if left to the market forces or private enterprise” (Business dictionary).
Demerit goods – goods or services that are unhealthy or even harmful for the society. Cigarettes and prostitution are examples.
Public Goods – “Goods which are non-rival and non-excludable – e.g. police, national defense” ( Pettinger, 2015).
Monopoly Power – a situation on a market with only one or few companies that impose the best prices for them.
Inequality – unfair distribution of resources between market participants.
Factor Immobility – “E.g. geographical / occupational immobility” (Pettinger, 2015).
Agriculture – “Agriculture is often subject to market failure – due to volatile prices and externalities” (Pettinger, 2015).
Information failure – a situation when there is a lack of fair information that prevents participants from making the right choice.
Situation 1. Firm A produces cement sifters in a process that includes the melting of metals and chemicals which give the sifters their strength. In the production process this waste is produced and released into a river that runs alongside of the plant. This situation is the vivid illustration of negative externalities. The firm A does not care about the environment and pollute river with production wastes. In this situation, the firm minimizes costs for lack of costs for treatment facilities and recycling of wastes. Nevertheless, water pollution is a serious problem for flora and fauna around the river as well as for people who live near it. Figure 1 shows us how great a problem does water pollution pose around the world.
Figure 1 - How great a problem does water pollution pose around the world.
Sources: World economic forum, 2015.
There exist two solutions:
Management of the factory realizes the importance of the minimizing harmful effects on the environment. Nowadays, eco-friendly production is a real trend and one of the best ways to attract new customers and increase its competitiveness.
Situation 2. Some states allow students to attend certain universities within the state tuition free if they are a resident of that state. As a result of this policy, the state's population is more educated and more productive in the workplace than many other states. This situation tells about positive externalities. From this situation both people and state benefit. Young people, who do not have enough money to pay for education, have an opportunity to improve their lives by getting a good education and well-paid jobs. In its turn, the state gets more educated population that increases productivity of the local economy and decreases the level of crimes. Moreover, students, who get education with the help of the government, make up a good voter support loyal to the government.
Subsidies for education is one of the most important part of social policy for any government. Subsidies for education are good investments for future nation prosperity. Except governmental subsidies, Banking Study loans and university grants are also very important tools to get benefits from positive externalities.
Situation 3. You live in a small subdivision with several residents. The subdivision has one short dirt road that provides access to all the homes. Bob, one of the residents of the subdivision, just inherited a large sum of money and decides to have the road in the subdivision paved. After the paving, Bob asked the other residents to pay their fair share of the costs for the paving, but they all refused. Situation 3 is the example of “free rider problem”. According to Business dictionary, a free rider problem “ is a market failure that occurs when people take advantage of being able to use a common resource, or collective good, without paying for it” (business dictionary). It means that people utilize public goods and do not pay a fare share in taxes. In our example, Bob had paid for the road – public good – from his own pocket and by his own will. He has no right to claim damages from his neighbors because nobody asked him to pay for the road. From Figure 2 we can see the graphs of the free rider problem.
Figure 2 – Free rider problem
Sources: Rittenberry, Tregarthen, 2009.
The ABC triangle shows deadweight loss that Bod suffered.
In this case Bob has two ways out: to rely on the conscience of the neighbors who use the road or to ask the local government for the assistance. The government could oblige people to pay for the road by implementing additional taxes
Situation 4. The President of the United States has determined that the cost associated with national defense has become too expensive. In an effort to reduce costs and balance the budget, the President has asked the public to voluntarily pay for their fair share of the costs associated with national defense. One of his advisors insists that this would not work; another advisor thinks it’s good policy. Which advisor is correct? The situation 4 again tells us about public good and the free rider problem. National defense is a public good that every citizen of a country benefits from regardless of age, sex or income. In this case, I think the idea to ask the public to voluntarily pay for their fair share of the national defense costs is not a good one. People will refuse to pay or will donate not enough sums of money hoping that someone richer will pay more. The best ways to raise money for national defense are implementing taxes and regularize governmental spending. On Figure 3 there shown Discretionary Spending of the USA in 2015. From this figure we may see that the main item of expenditure of the USA budget is Military – more than 50%. From this point we may conclude that such huge sums of money are impossible to rise from voluntary payments from citizens. Moreover, it is hard to predict how many people will pay what in its turn poses a threat to national security issues.
Figure 3 - Discretionary Spending of the USA in 2015.
Sources: National Priorities project
We live in times of rough competition and difficult economic rules that prevent the market from being perfect and ideal.
Market failures are the situations we face in our everyday lives.
There exist more than 10 different types of market failures.
Environmental problems are the most serious negative externalities people all over the world should be prevented from.
Positive externalities such as education bring benefits not only for third parties but also for the government that paid for them.
Public goods usually provoke a free rider problem that could be solved by governmental interventions.
Governmental interventions are the main and most effective way to prevent all types of market failures.
References
Morey, E. (2015). An Introduction to market failures. September 29, 2015. Retrieved from http://www.colorado.edu/economics/morey/4545/introductory/marketfailures.pdf
Pettinger, J. (2015). Market Failure. Retrieved from http://www.economicshelp.org/micro-economic-essays/marketfailure/
Business dictionary. Merit goods. Retrieved from http://www.businessdictionary.com/definition/merit-goods.html
World economic forum (2015). Increasing water stress. Retrieved from http://widgets.weforum.org/outlook15/09.html
Rittenberry, L., Tregarthen, T. (2009). Principles of Microeconomics. Flat World Knowledge. Pp.113-116.
National Priorities Project. Fighting for a U.S. federal budget that works for all Americans. Military Spending in the United States. Retrieved from https://www.nationalpriorities.org/campaigns/military-spending-united-states/
