What Are The Causes Of Market Failure

Published Date: 02 Nov 2017

First of all, the one of the reason will make market failure is externalities. It can be differentiate to negative externalities and positive externalities. For negative externalities, is the social cost exceeds the private cost paid by producers. At this situation, the market will produce more cigarettes than is optimal. One of the examples of negative externalities is the pollution of cigarettes. By solving this problem, there are two policies to use which is Command-and control policy and indirect tax. Command-and control policy also known as regulation. It can correct the externalities by making certain behaviors either forbidden or required. For example, the cigarettes will affect our healthy; therefore the government is set the maximum supplier and quantity of cigarettes so that the market will not produce cigarettes more than the quantity optimal and the supply curve will shift up to reach optimum quantity. Besides that, indirect tax also is one of the ways to solve negative externalities. Indirect tax is taxes on expenditure such as goods, foods, law and order, petrol, tobacco, social security and others. For example, to decrease the quantity of supply, government may require the seller to pay a certain dollar amount for each unit of tobacco. This will make each price of tobacco increase and it means that the cost of production will increase. To cover the cost, supplier will choose to decrease the quantity and this will cause the supply curve shift to left and the quantity of supply will meet the optimal too.

After the people take account of the external effect of their action. This is the graph will shift to.

Price

Supply

(Private cost)

Social Cost

Demand

(Private value)

Quantity

Negative Externalities Graph

Q Market

Q Optimum

Besides negative externalities, we have positive externalities also. The positive externalities happened when the social value of the good is greater than the private value. In addition, positive externalities will cause the quantity produced lower than the optimum quantity in the market. The one of the example for positive externalities is the provision of education. To internalize a positive externality, the government may use a subsidy. For example, they subsidies to consumers will decrease the price of merit goods such as allow the students to reduce the expenditure of doing on in full-time education. The purpose of subsidy is to boost the consumption and it will affect a raise in market supply and leads to a poorer equilibrium price. Moreover, subsidy also will help the demand curve shift to right to reach the market efficiency because subsidies is helping people decrease some burden by purchases goods or services.

After the people take account of the external effects of their actions. This is the graph will shift to.

Supply

(Private Cost)

Price

Social Value

Demand

(Private value)

Q Optimum

Q Market

Quantity

Positive Externalities

Secondly, market dominance by monopolies is one of the reasons that make market failure. This is because if the market is monopolies, it will lead to under -production and higher prices till the market can’t affordable. This will make the market having a surplus because the people can’t support the price. For example, TNB Sdn Bhd and PUAS Sdn Bnd is our sole provider for electricity and water and it is the evidence that keep giving excuses for a rise in price such as complain about rising cost for producing energy and utilities. Therefore, the consumers will always suffer in the end. To solve this market failure, the government may implement price control to the market. There are two type of price control, which is price ceiling and price floor. Price ceiling is set a legal maximum on the price at which a good can be sold. However, price floor is set a leg minimum on the price at which a good can be sold. From that example, to avoid the monopoly market keep raise the price to suffer consumer, government may set price ceiling to the market, which mean the TNB Sdn Bhd and PUAS Sdn Bhd can’t set the price higher than the price that government set but can lower than it. Nonetheless, price ceiling also has disadvantage for the market that is when the price ceiling is set lower than the equilibrium price, the ceiling is a binding constraint and a shortage is created.

This graph shows that the price ceiling is set equal to the equilibrium, so, it is no effect on the price or quantity sold.

Supply

Price

Price Ceiling

Demand

Price

Quantity

This graph shows that the price ceiling set below the equilibrium price. Therefore, it creates the shortage.

Supply

Price Ceiling

Shortage

Demand

Quantity

Besides that, the government also may implement a regulation that used to establish new competition into a market too. The purpose of this policy is to breaking up the presented monopoly authority of a service supplier. By introduce this policy, the competitor will increase and therefore the market will become perfectly competitive, which mean the competitor will lower the price to compete with other competitor. Furthermore, the market also will reach equilibrium by lower the price. Although the aim of this policy is good, it doesn’t mean that when the competitors come in the market then the policy will work. Sometime, there is still no effect to that company. For example, Microsoft Company is stay at market for a long extend of period, they are selling their product household to household for so many years without any rival product to compete with them. Since day by day, it already famous to household for the Microsoft name. Most of the household are using their software everyday or we also can say that they already can’t separate with Microsoft software in their life nowadays. Therefore, although they are other similar Operating Systems Company into the market lately such as Linux, it still can’t persuade the consumer change to their product even though it is free compared to the huge cost of Microsoft Licenses. At this situation, Microsoft is not fear to sell their license fee at a higher cost even though there are competitors came into the market.

In conclusion, there are a lot of policies that the government can use in the market when the market is inefficient. It can cure the market and even though make it become more efficient if the public policy is use in the right situation. However, they are some public policy is can’t work in some situation. For example, the policy of ‘introduce fresh competitor to market’ is not efficient to Microsoft Company because it affect by externality. Therefore, the policy has their advantage and disadvantage. Sometime it can become very useful to the market, on the other hand, it also can become poison to the market. It just depend the government implement which policy when having market failure by what reason.