The concept of market failure explains why an ideally competitive market fails to allocate resources efficiently. But it is more important to know how market forces work to help allocation of goods and services on Pareto principle. You see a perfectly competitive market does not exist in real life. So the failure of such a non-existent entity seems a puzzle.
On the other hand, not only the world but also the economic situations are changing very fast. The knowledge is imperfect. The consumer behaviors are as many as consumers may be. They can change their preferences for any reason. They not only have different levels of expectations from the government but also from the private managers. They can react in various ways to different government policies. In such situations, it seems too simple to generalize this model.
You can discuss different examples of failing markets around us and try to find out the most probable reasons situation. We can also try to find out the situation where some conditions are not met out which is essential for allocation of efficient resources in the conceptual free market mechanism. We can take a market failure as a condition where the market fails to deliver what is expected from a competitive market. It is helpful for managers to analyze what we can do to help allocation of resources efficiently in a given situation of inefficiency.
There can be a lot of factors which result in market failures. However, if you want to find out the crux of the failure, it is a situation where certain entity or entities (public or private) disturb the balance of market forces to fail efficient allocation of resources. When such a situation arises out of monopolies or property rights, the producer does not have any interest in reducing the cost of production as well as the prices. It results in wastage of resources on the production side in shape of high costs and on the consumer side in the form of prices. This situation can’t help the managers private as well as the public ones.
This term is also used where the inefficient allocation of resources is justified in the name of public goods like education, police, and firefighting in comparison to their private competitors. In a competitive market we find following elements:
1- Costs and benefits are included in the price.
2- Everybody can have easy access to the same information as the producer can have.
3- There is no free ride as the people not paying can’t enjoy the benefits.
This type of market mechanism includes costs as well as benefits in the price of products. However, in case of failure, we find these all components or either of them missing so outcome does not help the managers in making right choices. When the market is working properly, your financial decisions cause more ‘total gain’ than ‘total loss’ though individuals may find themselves at a loss.
Generally, the market failures are short lived as they can’t continue for long without the support of the government. Suppose some producer or group of producers succeed to introduce a new or better product in the market at a low price; the competitors start losing their ground. If they don’t follow the lead or forced not to enter the market (either by regulations or costs of the products) a monopoly comes into being. The monopoly results in higher prices and more profits with the social loss. Without the support of the government, such a situation can’t prolong as other competitors can copy and produce the same product without wasting initial production costs and risks. For example, there are allegations on Microsoft © to copy certain elements from already existing companies when Bill Gates entered into the business of computers. Similarly, Apple’s touchscreen IPAD has been followed by many players like Samsung.
In case of many products, even the government can’t support monopolies. For example, Coca-Cola and Pepsi Cola are two giants in the soft drinks market. Some may term them in monopolistic competition, but still, the situation does not fall in the sense of market failure. First, there are many other small competitors in the market (like Gourmet). If these two giants decide to make a cartel and increase prices unduly, many other competitors will jump in with non-branded but low prices. Second, there are many different soft drinks which can be substituted for Pepsi and Coke like milk, juices, energy drinks and pure water.
In either situation, the government intervention can either help the market failure to continue to reduce the social impact by cracking down on the cartels and monopolies.
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