Market failure is the situation that the market fails to achieve economically efficient outcome in an economy.

There are some basic types of market failure: monopoly, public goods, merit and demerit goods and externalities. Government intervention may seek to correct for the distortions created by market failure and to improve the efficiency in the way that markets operate: Pollution taxes to correct for externalities, Taxation of monopoly profits (the Windfall Tax), Regulation of oligopolies/cartel beh aviour, Direct provision of public goods (defence), Policies to introduce competiti on into markets (de -regulation), Price controls for the recently privatised utilities . Monopoly that does not pass on the benefits of the economies of scale to consumers wil l be inefficient, at least allocatively. A mon opoly firm charges a price exce eds the marginal cost when the marginal cost equals the marginal revenue, so it provides a product wit h a small amount and high price, so its an example of market failure. The classical economic case against monopoly is that
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Price is higher and output is lower under monopoly than in a competitive market

This causes a net economic welfare loss of both consumer and producer surplus

Price > marginal cost - leading to allocative inefficiency and a pareto sub -optimal equilibrium.

Rent seeking behaviour by the monopolist might add to the standard costs of monopoly. This includes high (possibly excessive) amounts of spending on persuasive advertising and mark eting.

Libenstein's X -inefficiency may also result if the monopolist allows cost efficiency to drop. The lack of real competition may give a monopolist less of an incentive to invest in new ideas or consider consumer welfare. It can also be argued that eve n if the monopolist benefits from economies of scale, they will have little incentive to control production costs and 'X' inefficiencies will mean that there will be no real cost savings.

There are real costs to society from "monopoly", they may be offset by some associated benefits (Schumpeterian innovation, economies of scale, etc.) Remedies proposed for monopoly hav e usually involved some form of government intervention. - Legislation making restriction of competition illegal (what Canadians call "a nticombines" policy and the Americans "anti-trust" policy) - public utility regulation (an agency of government sets price and output requirements for private firms in the industry) - outright public ownership of the industry or some of the firms in it. Few modern markets meet the stringent conditions required for a perfectly competitive market. The existence of monopoly power is often thought to create the potential for market failure and a need for intervention to correct for some of the welfare conseq uences of monopoly power. Public goods cant be provided by a free market. They have to be provided by the state. The lack of public good may cause market failure. There are two main characteristics of public goods: non -excludability and non -rivalry. Examples: Street lighting / Lighthouse

Protection, Police services, Air defence systems, Roads / motorways, Terrestrial television, Flood defence systems, Public parks & beaches Partly this is because of the free -ride problem. Consumers can take a free ride wi thout having to pay for the good or service. Consider the case of the provision of traffic wardens and safety signs on roads. One person's benefit from these services is not unique - other motorists benefit from the service as well - but they cannot be sto pped and asked to pay for the benefits they derive. The problem of "public goods" - Benefits are widely -shared and cannot be restricted to those who pay for their production - consequently such goods tend to be produced in less than socially-optimum quantities under a system of pure market choice (fire protection, public sanitation, national defence .... - Usual remedy again is government intervention to increase the production of such goods beyond the output private firms would produce in response to purely market incentives. The obvious solution is that these goods are provided collectively by the government, and then financed through taxation of individual households and businesses. Merit and demerit goods will be under or over -provided by an economic market if left to the market forces alone for their provision. The under -provided merit goods and over -provided demerit goods may bring market failure With merit goods -Both the public and private sector of the economy can provide merit goods & services. Consumption of merit goods is thought to generate positive externality effects where the social benefit from consumption exceeds the private benefit. Examples: Health services, Education, Work Training, Public Libraries, Citizen's Advice, Inoculations. The government often provides merit goods "free at the point of use" and then finances them through general taxation. Examples of merit goods that are largely state provided include primary health care available to people through the National Health Service, books borrowed through the services of local authority libraries. There is growing evidence of a widening in health inequalities in Britain partly arising from an increase in relative poverty. Spending on the National Health Service is an important vehicle for reducing these inequalities - but there will always be a divide between those who can afford prompt, good quality health care and many millions of people wholly dependent on state provided health services.

De-Merit Goods De-merit goods are those goods or services that create negative externalities when the product is consumed. This reduces the social marginal benefit of consumption and also

leads to potential market failure through over -consumption. Examples are alcohol, cigarettes and various drugs. The government may decide to intervene in the market for these goods and impose taxes on producers and / or cons umers. Higher taxes cause prices to rise and sh ould lead to a fall in demand. Or it may choose some form of regulation as an alternative strategy. Consumers may themselves be unaware of some of the negative externalities that these goods create they have imperfect information. Externalities are costs (negative externalities) and benefits (po sitive externalities) that are not reflected in the free market prices and have passed onto those who are not necessary parts to the activity. They are often called spill over effects. Externalities create a divergence between the private and social costs of production.

Inequality Market failure can also be caused when the inequality exist. Wide differences in income and wealth between different groups within our economy leads to a wide gap in living standards between affluent (rich) households and those experiencing poverty. Society may come to the view that too much inequality is unacceptable. The government may decide to intervene to reduce inequality through changes to the tax and benefits system and also specific policies such as the national minimum wage. When negative production externalities exist, marginal social cost is more than private marginal cost. In the diagram below, the marginal social cost of production exceeds the private costs faced only by the producer/supplier of the product. In Vietnam, an example is about a supplier of fertiliser to the agricultural industry creates some external costs to the environment arising from their production process

We can see from the diagram below that the profit -maximising level of output is at Q1. However the socially efficient level of production would consider the external costs too. The social optimum output level is lower at Q2 .

This leads to the private optimum output being greater than the social optimum level of production. The producer creating the externality does not take the effects of externalities into their own cal culations. We assume that producers are onl y concerned with their own self-interest. In the diagram above, the private optimum output is when where private marginal benefit = private marginal cost , giving an output of Q1. For society as a whole though th e social optimum is where social marginal benefit = social marginal cost at output Q2.The failure to take into account the negative externality effects is an example of market failure. NEGATIVE CONSUMPTION EXTERNALITIES Consumers can create externalities when they purchase and consume goods and services.
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Pollution from cars and motorbikes Litter on streets and in public places Noise pollution from using car stereos or ghetto-blasters Negative externalities created by smoking and alcohol abuse Externalities created through the mis treatment of animals Vandalism of public property Negative externalities arising from crime

In these situations the marginal social benefit of consumption will be less than the marginal private benefit of consumption. (i.e. SMB < PMB) This leads to the good or service being over-consumed relative to the social optimum. Without government

intervention the good or service will be under -priced and the negative externalities will not be taken into account. Again there will be a dea dweight loss of economic welfare.

In the example shown in the chart above we illustrate the potentially negative effects of people consuming cigarettes on other consumers. The disutility (dis-satisfaction) created leads to a reduction in the overall social benefit of consumption. If the cigarette consumer only considers their own private costs and benefits, then there will be over -consumption of the product. Ideally, the socially efficient level of cigarette consumption will be lower (Q2). The issue is really which policies/strategies are most appropriate in reducing the total level of cigarette consumption. Remedies for Market Failure
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Use of tax and subsidy schemes to bring private costs and benefits into line with social costs and benefits.

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Tax producers of negative externalities Subsidize producers of positive externalities The "Coase Theorem" Externalities a consequence of incomplete assignment of property rights

Assigning property rights allows solution of efficiency problem through private negotiation

European practices
 

private trout streams, forests, ... political acceptability in North America of private ownership of "natural resources" -- "Crown lands"?