Question

market failure and role of the government

Answer 1

An imperfect market outcome can be corrected by a change in the incentive structure or reallocation of resources. Economists often differ in their opinion about the type of market failure and the corrective measures required to resolve it.

What is a Market Failure?

It’s impossible to correct market failures concept without understanding what it exactly is and why it stays. The most common interpretation of a market failure—failing to attain the standards of “a perfect competition in the general equilibrium of economics”— is easily identifiable in most, if not all the markets. While the price equilibrium is a shifting target, consider all sellers and buyers in the market as sprinters in a race, with the exception that the finishing line keeps changing between right, left, up and down.

A better pragmatic interpretation of market failures is where the economic participants aren’t properly incentivized for pushing the markets towards more acceptable results. This is also where the most academic literature on market failure is concentrated.

A market failure has a negative effect on the economy due to the non-optimal allocation of resources. In other words, the social cost to manufacture the goods or services i.e. all the opportunity costs of input resources used in the creation, are not minimized. This also leads to the wastage of resources.

A market failure can be usually corrected by allowing consumers and competing sellers to shove the market towards equilibrium over a period of time. Markets often tend to constantly move towards equilibrium, but never quite attaining it because of limitation to human knowledge, besides changes in global situations.

Many policy experts and economists seek possible regulations and interventions for compensating a perceived market failure. Subsidies, tariffs, punitive or redistributive taxation, trade restrictions, disclosure mandates, price ceilings and several other economic distortions were mooted to correct inefficient outcomes.

Other economic experts argue that a market is recognizably imperfect. Market failures, however, are improperly framed. Instead of asking whether market failures are related to perfect competition, they say that the question must revolve around whether a market performs better than other processes which humans may trigger.

Free market economists like Milton Friedman, FA Hayek, and others, have argued that a market is the only recognized discovery process capable to adjust correctly to all inefficiencies. They say that a regulation can interfere with the process causing inefficiencies to deteriorate than better.