Market Failures, Externalities and Public Goods

Market Failures

As productive and as efficient as our modern
economy is we cannot meet all of our needs and all of our wants. This
being the case, an certainly no one would expect perfection, there is
clearly some failure on the part of the market to provide these goods
and services. While the term failure may be a tad harsh, it is the
essence of what has occurred… a market failure.

Market failure – The situation that exists when
the market fails to function properly. Market failure occurs when the
following condition exist:

  • When adequate competition does not exist.
    In an age where mergers are all too common, the result has been an
    increase in larger and fewer firms in many industries. In extreme
    cases, this results in a monopoly. The greatest threat that a
    monopoly poses is that it denies consumers the benefit of choice
    and competition. Because a monopoly occupies the top spot in its
    market, it can use its position to impede competition and restrict
    production. Thus in the end there are artificial shortages and
    higher prices. Inadequate competition may also enable a firm to
    influence politics by means of economic strength. In the past
    there have been executives who furthered the political careers of
    those closest to them. Though it is not necessary for a business
    to be a monopoly in order to influence politics, it certainly
    helps. A large corporation may simply want tax brakes on a state
    or local level. If the government refuses, then the plant may
    threaten to moves its facilities elsewhere. Because the government
    does not want an economic loss to its area, it may acquiesce to
    the demands of the corporation. In order to efficiently allocate
    resources, consumers, business people, and government officials
    must have adequate information about market conditions. Some of
    which is easy to obtain like sales prices or want ads. Yet there
    is a little more difficulty in ascertaining information about a
    companies earnings and dividends.

  • Buyers and sellers are not well informed.
    Without information uneducated decision are made. This leads to
    mistakes and thus, market failure.

  • Resources are not free to move from one
    industry to another. This is known as resource immobility. Resource immobility is a difficult problem in any
    economy. The efficient allocation of resources requires that land,
    labor, entrepreneurs, and capital be free to move to markets where
    returns are the highest. But there are times when a business that
    is located in a certain community decides to up and leave, leaving
    hundreds unemployed. The consequence of the move is a reason that
    may hamper the corporation from taking its business elsewhere.
    Resource mobility is considered ideal in the competitive market
    economy, but is actually much more difficult to accomplish. When
    resources are immobile, markets don’t function, as they should.

  • Prices do not reasonably reflect the costs
    of production. This represents a problem because then wealth is
    being redistributed unfairly and prices are too high.


an economic side effect that affects an uninvolved third party. These
are also examples of market failures. There are two types of

  • Negative externality– harmful side effect that affects an uninvolved
    third party. In most events, it constitutes external cost.

  • Positive externality– beneficial side effect that affects an uninvolved
    third party.

    An externality, by definition, is an
    economic side effect that either benefits or harms a party not
    directly involved in the activity. A negative externality is an
    action that harms a third party resulting in external cost. An
    example of this would be the construction going on on the LIE.
    Because the roadway is being widened, trees along side have been
    taken down, thus exposing the once secluded service road and the
    homes that are alongside it. This construction has annoyed
    drivers, who have to put up with the mess and homeowners as well.
    A positive externality is if the economic action benefits a third
    party. Such an example can be drawn from the previously mentioned
    one. The construction on the LIE may cause traffic tie-ups, but
    local businesses may benefit from the traffic, which detours by
    their shops, and the workers who may require services from one of
    the businesses.

Public Goods

Public goods are those goods and services

provided by the government because a market failure has occurred and
the market has not provided them.
Sometimes it is in our benefit to not
allow for a market provision. In the case of police, national defense
and public education it can be argued that private provision of these
services would be less desirable for a variety of reasons.

Public goods are economic products that are
consumed collectively, like highways, sanitation, schools, national
defense, police and fire protection.

All members of society should theoretically
benefit from the provision of public goods but the reality is that
some need them more then others. For example the wealthy do not need
welfare and the elderly still pay for school taxes. This leads to the
inevitable argument about paying for public goods…. taxes!