Causes for Market Failure -
- Externalities - Actions by market agents often created extra
benefit or losses in course of their action. There are positive
(benefits) and negative (losses) externality in consumption and
production. These externalities create situation which
decreases/increases social benefits/losses. The private market
cannot take into cosideration this externalities. The free market
mechanism cannot increase optimal allocation for positive
externlality or decrease for negative externality. This causes the
market to fail as the social optimum is not achieved.
- Public goods - This are those goods who production cost do not
increase with number of users. This goods are essentially for the
existence of a welfare state. Private sellers will not provide this
goods as there are no profits here. Private agents seek to maximize
profits over social well being. Hence private markets will not be
able to provide this goods at the required level. Public goods are
important as they facilitate many economic transactions and
benefits. Without public goods or for a lack of it, the market will
fail to produce the optimum and required quantity of goods.
- Asymmetric Information - There is not always full transparancy
of information regarding the goods sold in the market. This allows
one party to benefit at the cost of others. A seller who knows the
value of his good can sell the good at a higher price to a buyer
who does not have complete information. Such asymmetry causes
markets to fail, as surplus is sabotaged in the process.
- Market Power - It often happens that due to endowment and
market conditions, one specific seller or buyer has the power to
charge/pay their desired price level. E.gs are monopoly and
monopsony markets. Here one authority has sole control over price
setting. This way less quantity can be sold at higher prices
causing improper distribution. Thid causes market failure.
The degree of welfare loss is measured by Dead Wieght Loss. This
term measures the number of transactions lost due to the higher
price, tariff or externality. This measures loss in consumer and
producer surplus.