Question

In: Economics

Market failure is defined as “the inability of a market to produce a desirable product or...

Market failure is defined as “the inability of a market to produce a desirable product or produce it in the “right amount.” Explain how may this happen and what will be the likely impact of such occurrence. Give two examples resulting in overproduction or underproduction. For each case give what may be considered as intervention in the market for its correction as “second best.”

Solutions

Expert Solution

Market failure is market left on its own fail to allocate resources efficiently; without the intervention of government. This leads economic inefficiency. For example, government introduce subsidies to have enough goods and services, this is a market failure where demand still exists but supply is no longer limited. Negative externalities are the causes of market failure. The effects of production and consumption are not directly reflected in the market. Consider the over production of gasoline. This leads a negative externality because people who do not used in the car. The over production of the gasoline increase the cost of air pollution. This will negatively affect the climate and the health of the people. The overall social cost of this becomes the summation of private cost of the firm and the external cost of bystanders affect this pollution.
Government policies like price floor, price control and price ceiling are the effective measures for this market failure. The implementation of ceiling price will make the withdrawal of sellers from the market. This lowering price will attract the consumer’s demand. To maintain efficiency sometimes government merge this price ceiling with the rationing. The consumers are willing to find the second best good in the market other than gasoline. This will increase economic efficiency and market stability.


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