Question

Discuss with precision what economists mean by the term market failure and discuss some of the major issues that our democracy faces. In your opinion, what could be done in (if you think changes need to be made) in order to make a government that is more responsive to the needs of the people?

Answer 1

The existence of externalities is an important reason which prevents the achievement of Pareto optimality ( or maximum social welfare ), that is , causes market failure, even when perfect competition prevails. Therefore economists mean the existence of externality when they say market failure.

Externalities could be positive as well as negative. Positive externalities benefit the society whereas negative externalities have detrimental effects on the society and the economy.

Some of the example of negative externality is environmental pollution by firms, the cost of which society bears in terms of deterioration of health and life expectancy. Some of the major issues that our democracy faces are increasing environmental pollution, gun control and government's failure to regulate the gun control laws, climate change etc.

Government can impose tax on those economic activities that are creating negative externalities in order to eliminate adverse effects of a negative externality.

Government can impose a tax equivalent to negative externality to bring back production of the firm to the optimum level.