Question

a) What is allocative market failure? (30 words)

b) State four reasons for allocative market failure.

Answer 1

Ans :-

Means

An allocatively efficient economy produces an "optimal mix" of commodities. A firm is allocatively efficient when its price is equal to its marginal costs (that is, P = MC) in a perfect market. ... When a market fails to allocate resources efficiently, there is said to be Allocative market failure.

Reasons

1.Market Efficiency

Before discussing the specific to the failings of markets, first consider perfection in the form of market efficiency. Efficiency in the allocation of resources is achieved when value received is equal to value foregone. With this equality, value cannot be increased by changing the allocation of resources.

Unfortunately for markets to achieve efficiency, a few conditions must be achieved:

• The Unfortunately for markets to achieve efficiency, a few conditions must be achieved: must be competitive. Competition among buyers and sellers is what creates equality between demand price and supply price.
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• The market must not have any benefits or costs external to the market. The demand price must reflect all value generated from a good and the supply prices must reflect all opportunity cost of foregone production.
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• The market buyers and sellers must have complete (ideally, perfect) information about prices and alternatives.

2.Public Goods

Public goods are goods that can be consumed simultaneously by a large number of people without the consumption by one imposing an opportunity cost on others, what is termed nonrival consumption. They are further characterized by the inability to exclude nonpayers from consumption. Nonrival consumption means that public goods are efficiently allocated if provided at a zero price, something markets are seldom inclined to do. Moreover, the inability to exclude nonpayers gives rise to the free-rider problem, which further inhibits the voluntary exchange of public goods through markets.

Simple examples of public goods include national defense, public health and environmental quality. In each case consumption by one does not impose an opportunity cost on others and nonpayers cannot be excluded from consumption. And in each case, markets fail to efficiently allocate the production, consumption, or provision.

3.Market Control

Market control arises when buyers or sellers are able to exert influence over the price of a good and/or the quantity exchanged. The ability to control the market, especially the market price, prevents a market from equating demand price and supply price.

Market control on the supply side allows sellers to set a demand price, the value of the good produced, above the value of goods not produced. An extreme example of market control on the supply side exists with monopoly, a market with a single seller. A less extreme, but more common example, is oligopoly, a market with a small number of large sellers

Simple examples of markets with supply-side or demand-side control include city-wide electrical distribution (monopoly), automobile manufacturing (oligopoly), employment in a company town (monopsony), and employment in professional sports (oligopsony)

4.Government Inefficiencies

While market failures can be corrected, in principle, only through some sort of government action, government intervention does not guarantee a solution nor an efficient allocation of resources. The reason is that governments are also imperfect. Governments have their own set of inefficiencies.