10 boys 10 girls
Other causes of market failure
i. Imperfect competition
● In practice power often lies to a greater extend with producers than
consumers eg monopolists and oligopolists
● They restrict output and raise prices and produce where price exceeds
marginal cost
● They can also prevent new firms from entering the industry thereby
preventing full adjustments to changes in consumer demand occurring
● All this leads to market failure
● A monopoly is a single supplier of a commodity
● Monopolies are inefficient because there is no competition
● A monopoly produces a lower output Q0 and charges higher price P0 ,
however from the society’s point of view production must be increased
to Q1 and prices reduced to P1
● Monopolies contribute to market failure because there is a dead weight
loss shown by a triangle
ii. Lack of information
● If consumers are to maximise their utility they need to have full
information about the products they wish to buy and the producers
selling them
● Merit goods are under consumed while demerit goods are over
consumed because of lack of information
● Lack of information is known as asymmetric information eg consumers
may not have the best information on the appropriate quantities of
prescribed drugs to take resulting in overdose and addiction
● Workers may also been unaware of job opportunities outside their
current employment and ,may not fully appreciate all the advantages and
disadvantages including health risk of the jobs they currently have
● Entrepreneurs may also lack information about the cost , availability and
productivity of factors of production and maybe operating on the basis of
incorrect information about the reliability and ;life span of the machines
they use
iii. Immobility of factors of production
● Factors of production particularly labour can experience difficulty in
moving occupationally and geographically to meet changes in consumer
demand
● This means that supply may adjust slowly and inadequately
● With greater technological change there is an increasing need for
workers to be flexible , to be willing to update their skills throughout
their working life , change employers occupations and work patterns
iv. Short terminism
● Private sector entrepreneurs are often criticised for the persuing short
term objectives at the expense of long term goals
● Its because they are driven by the profit motive
● This can result in the over production of consumer goods , under
production of capital goods and a failure to develop new methods of
production and new products
v. Imperfect distribution of income and wealth
● The market economy provides opportunities for people to earn an
income and acquire wealth
● However opportunities for earning income are not equally distributed eg
discrimination distorts earnings and can result in women , people from
other ethnic minorities and the disabled earning less for the same work
as able bodied white male employees
● This all leads to market failure
Government failure
● The government may implement policies set to reduce market failure
● This is expected to increase efficiency in markets resulting in economically desirable
outcomes
● However practically all may not work as planned and the government may also fail
Lack of information
● The correct policies can only be introduced if the government has
correct information
● Inaccurate information may result in the implementation of
policies which can lead to greater economic inefficiency
● In most cases there is lack g information about the true value of
the negative externality
● It is often very difficult to give accurate figures for the value of
negative externality such as pollution
● It is difficult both to put an accurate figure to all the cost imposed
and to trace the source of the pollution itself
● It therefore becomes very hard to impose the correct value of a
tax that attempts to reduce production to an efficient level
● In cases where demand is estimated inaccurately then the wrong
amount of goods can be supplied eg merit goods
Conflicting objectives
● Government often face conflicting objectives since every decision
made by the government have an opportunity cost
● In some cases a decision is made where welfare gains from the
alternative for gone would have been even higher
● Government may take the wrong policy decision where they are
such conflicts of objectives choosing the option which gives lower
economic welfare rather than higher economic welfare
● They may do this due to lack of information or deliberately
because they wish to reward their supporters in the electorate
who voted for them
Administrative costs
● Sometimes the administrative costs of correcting market failure is
so light that it over ways the welfare benefits from the correction
of market failure
● Administrative cost include planning costs ,implementation costs
and monitoring costs
Market distortions
● In some cases government intervention to correct one market
failure leads to the creation of far more serious market failures
● For example if the government intervenes using flat prices , there is
need for further government intervention which may require
resources hence adding more to administrative costs
Mistiming
● It occurs when the government intervenes to correct market failure at
the wrong time usually when its too late
● Mistiming may be caused by time lags eg recognition lags ,
implementation lags and impact lags
Cost –benefit analysis
● It attempts to evaluate social costs and benefits of proposed investment projects as
a guide when deciding upon the desirability of these projects
● It’s a method of assessing investment projects by considering their social costs in
relation to social benefits they bring
● It is usually applied to those projects where it is expected that there will be a
significant difference between private and social cost and benefits
● In short it intends to enable the decision maker to choose between alternative
projects on the bases of their potential contribution to social welfare
● The decision criteria is as follows
● SMB>SMC –the project should proceed
● SMB =SMC – government will be indifferent and will take other factors into
consideration
● SMB <SMC – the project should nor proceed
● CBA ensures that the policy makers consider the effect of their actions on the wider
community
Stages in cost benefit analysis (CBA)
a) Identification of all relevant cost and benefits –both internal and external cost have to
be considered
b) Putting a monetary value on all relevant costs and benefits
c) Forecasting future costs and benefits where appropriate
d) Decision making that is interpretation of CBA results
Problems of cost benefit analysis
● Private costs involved can easily be identified as well as private benefits .However
external benefits and costs are not so easy to measure since by definition they don’t
have a price attached to them
● CBA is quite expensive and is not used in many projects because if difficulties in
evaluation
● It is time consuming and it wastes scarce resources
● Money values placed on intangibles such as the value of the environment are
sometimes extremely speculative
● CBA estimates shadow prices which do reflect the actual prices of social costs and
benefits
● CBA is usually used where it is assumed that market failure is present
● Government decisions maybe influenced by politics
Advantages
- its purpose is to give guidance decision making ,it is used particularly by government to
evaluate important investment projects such as dam construction as well as bridge and road
construction
● CBA allows all costs and benefits of an investment project can be analysed not only
private cost and private benefits
● It is easy to make a decision when costs and benefits are in monetary terms
● Provides an objective way to compare the projects, this eliminates the emotional
element in decision making.
● It is used to determine the value of a project that is to be done.
