Question

Outline and explain in detail four types of market failure. What types of problems do market failures give rise to in the economy? Please give an example for each of the market failures you have outlined. Diagrams are not required in this question. (30 marks, approximately 300 words please).

Answer 1

Market failures refers to the various imperfections in the exchange process that prevents the efficient allocation of scarce resources by the market.The four types of market failures are as follows:
1.Public Goods

Public goods are consumed simultaneosly bu a large group of consumers and they cause market failures because non payers cannot be excluded from using them which inturn leads to free rider problem that hinder voluntary exchange of the same.For example environmental quality;its consumption by one does not impose an oppurtunity cost on the other and the non payers can't be exclude thus leads to market inefficency.

2.Market Control

market control is the situation in which buyer or seller is able to exert influence on price or quantity exchanged of the goods.And this will restrain the market from equating demand and supply price.For example a monopoly market with a single seller is an extreme case of market control on the supply side.

3.Externalities

An externality refers to a benefit or harm caused to a third party due to production of goods ,which are not paid or penalised respectively.And that means the price of the good does not reflect the true value of th good hence the market does not achieve efficient allocation.For example, pollution.pollution caused due to production is not involved in the supply price and omitted cost is one that is imposed on those who are harmed by pollution.

4.Imperfect Information

Imperfect information is a situation in which buyers or sellers do not have necessary information to decide about price or quality of product.For example in case of a used car the buyer have less information than the seller i.e there is assymetric information .And it leads to market inefficency due to lack of sound economic decisions.

Problems that market failures cause to the economy are:

• It causes imbalances and leads to allocative inefficency.
• It leads to under or over consumption of goods and services.
• Competition in the market is adversely affected
• Consumers get exploited
• Stability of economy is affected.