Market failure refers to the situation where the free market fails to achieve an outcome that maximizes society’s welfare, of which imperfect information and the immobility of the factors of production, which refers to the inability of resources to move perfectly from one market to another in response to changing market conditions, would lead to market failure as well. In my essay, I explain how the above two factors cause market failure.
Imperfect information is the situation where people engage in economic transactions without having perfect information of what they are buying, due to a discrepancy between the perceived benefit or cost and the actual benefit or cost. Due to the lack of perfect information, consumers end up buying something that is not what they really want or need. This is because consumers are often swayed by persuasive advertising and sales staff pushing products based on commission. As a lot of time and effort is required for one to acquire all the necessary information as they lacked the time and expertise to learn about the many products in the market, this principal-agent problem is likely to persist. Hence, when a consumer buys a good that is not what they really want or is less suitable, his welfare is below the socially optimum level and this gives rise to market failure.
Imperfect information also contributes to market failure that arises from negative externalities and the presence of demerit goods. This is because adverse effects are imposed on third parties when these goods are produced or consumed. Externalities are defined as third party spillover effects, where third parties are affected when goods are produced or consumed, and demerit goods are goods which the government deems undesirable in the light of consumers lack of information or due to the negative externalities imposed on third parties.
In this case of demerit goods, individuals are unaware of the social cost incurred during their consumption of the good. Both negative externalities of production as seen in the figures below. Without government intervention, MPB = MPC and output is at Qp. The social equilibrium Qs is at MSB = MSC. Since MSC > MSB, a deadweight loss is generated. Since Qp > Qs, the good is over-produced.
In this case of demerit goods, individuals are unaware of the social cost incurred during their consumption of the good. Both negative externalities of production as seen in the figures below. Without government intervention, MPB = MPC and output is at Qp. The social equilibrium Qs is at MSB = MSC. Since MSC > MSB, a deadweight loss is generated. Since Qp > Qs, the good is over-produced.
[Insert diagrams on negative externalities from production and consumption]
As for demerit goods, when MPB = MPC, the output is at Qp. However, the social outcome Qs is where MSB = MSC. Between Qp and Qs there is a loss of potential welfare (deadweight loss). Since Qp > Qs, the good is said to be over-consumed.
As for factor immobility, there are two major types – occupational and geographical immobility. Occupational immobility of labour arises because workers lack the required education or skills to take on new jobs in another industry. For instance, people working in fields with low technology will find it hard to work in Silicon Valley due to their lack of knowledge, thus making them occupationally immobile. On the other hand, geographical labour immobility exists in large countries when there are barriers to people moving from one region to another in search of jobs. This barriers include family and social ties and cost involved in moving to another area to settle down. Large countries like the USA and the UK will face these sorts of geographical immobility problems and issues.
Market failure arises as resources are unemployed due to factor immobility and hence the economy is producing inside its PPC. Hence, the outcome is productive inefficient and also allocatively inefficient.
[Insert a diagram on production possibilities curve]
The diagram shows that there are unexploited resources untapped, and therefore there is productive inefficiency. Also, there could be market failure due to allocative inefficiency. This is because resources are unable to flow from contracting to expanding markets. Hence, society’s welfare is not fully maximized and it can be argued that market failure results.
In conclusion, imperfect information is often present in market dominant firms such as oligopolistic and monopolistic firms as they are price setters with large market power, often arising from possession of asymmetric information. Imperfect information prevents consumers from knowing all the prices and the product production processes also. Therefore, it is difficult to remove the presence of imperfect information as it is so prevalent. Factor immobility is also another common cause of market and it is difficult to be eradicated. Hence, market failure would tend to persist.
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