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Encyclopedia > Market failure

Market failure is a term used by economists to describe the condition where the allocation of goods and services by a market is not efficient. The first known use of the term by economists was in 1958 [1], but the concept has been traced back to the Victorian philosopher Henry Sidgwick [2]. The belief that markets can fail is a common mainstream justification for government intervention in free markets[3] – however, not all economists believe that market failures occur, or that they are compelling arguments for government intervention, due to government failure[4]. Economists, especially microeconomists, use many different models and theorems to analyze the causes of market failure, and possible means to correct such a failure when it occurs[5]. Such analysis plays an important role in many types of public policy decisions and studies. Look up Market in Wiktionary, the free dictionary. ... Economic efficiency is a general term for the value assigned to a situation by some measure designed to capture the amount of waste or friction or other undesirable economic features present. ... Henry Sidgwick Henry Sidgwick (May 31, 1838–August 28, 1900) was an English philosopher. ... Mainstream economics is the term used to distinguish the economics profession in general from advocates of various heterodox schools, including Austrian economics and Marxian economics. ... A free market is an idealized market, where all economic decisions and actions by individuals regarding transfer of money, goods, and services are voluntary, and are therefore devoid of coercion and theft (some definitions of coercion are inclusive of theft). Colloquially and loosely, a free market economy is an economy... Government failure is the public sector analogy to market failure and occurs when a government does not efficiently allocate goods and/or resources to government consumers. ... Microeconomics is a branch of Economics that studies how individuals, households, and firms make decisions to allocate limited resources,[1] typically in markets where goods or services are being bought and sold. ... Public policy is a course of action or inaction chosen by public authorities to address a problem. ...

Contents

Causes of market failures

See also: public goods, monopoly, monopsony, and oligopoly

In mainstream analysis, a market failure (relative to Pareto efficiency) can occur for three main reasons[6]. First, an agent in a market can gain market power, allowing them to block other mutually beneficial gains from trade from occurring. This can lead to inefficiency due to imperfect competition, which can take many different forms, such as monopolies, monopsonies, cartels, or monopolistic competition. Second, the actions of an agent can have "side effects" known as externalities, which are innate to the methods of production, or other conditions important to the market[6]. Finally, some markets can fail due to the nature of certain goods, or the nature of their exchange. For instance, goods can display the attributes of public goods or common-pool resources, while markets may have significant transaction costs, agency problems, or informational asymmetry[6]. In general, all of these situations can produce inefficiency, and a resulting market failure. In economics, a public good is one that cannot or will not be produced for individual profit, since it is difficult to get people to pay for its large beneficial externalities. ... A monopoly (from the Greek language monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a product or service, in other words a firm that has no competitors in its industry. ... In economics, a monopsony (from Ancient Greek μόνος (monos) single + ὀψωνία (opsōnia) purchase) is a market form with only one buyer, called monopsonist, facing many sellers. ... An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). ... Pareto efficiency, or Pareto optimality, is an important notion in neoclassical economics with broad applications in game theory, engineering and the social sciences. ... In economics, an agent is an element of a model who solves an optimization problem. ... In economics, market power is the ability of a firm to alter the market price of a good or service. ... In economic theory, imperfect competition, is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied. ... A monopoly (from the Greek language monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a product or service, in other words a firm that has no competitors in its industry. ... In economics, a monopsony (from Ancient Greek μόνος (monos) single + ὀψωνία (opsōnia) purchase) is a market form with only one buyer, called monopsonist, facing many sellers. ... A cartel is a group of formally independent producers whose goal is to increase their collective profits by means of price fixing, limiting supply, or other restrictive practices. ... Monopolistic competition is a common market form. ... In economics, an agent is an element of a model who solves an optimization problem. ... In economics, an externality is a cost or benefit resulting from an economic transaction that is borne or received by parties not directly involved in the transaction. ... In economics, a public good is one that cannot or will not be produced for individual profit, since it is difficult to get people to pay for its large beneficial externalities. ... A common-pool resource (CPR), alternatively termed a common property resource, is a particular type of good consisting of a natural or human-made resource system, the size or characteristics of which makes it costly, but not impossible, to exclude potential beneficiaries from obtaining benefits from its use. ... In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange. ... In economics, the principal-agent problem treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. ... In economics, information asymmetry occurs when one party to a transaction has more or better information than the other party. ...


More fundamentally, the underlying cause of market failure is often a problem of property rights. As Hugh Gravelle and Ray Rees put it, This page deals with property as ownership rights. ...

A market is an institution in which individuals or firms exchange not just commodities, but the rights to use them in particular ways for particular amounts of time. [...] Markets are institutions which organize the exchange of control of commodities, where the nature of the control is defined by the property rights attached to the commodities[3].

As a result, an agent's control over the uses of their commodities can be imperfect, because the system of rights which defines that control is incomplete. Typically, this falls into two generalized rights – excludability and transferability. Excludability deals with the ability of an agent to control who uses their commodity, and for how long – and the related costs associated with doing so. Transferability reflects the right of an agent to transfer the rights of use from one agent to another, for instance by selling or leasing a commodity, and the costs associated with doing so. If a given system of rights does not fully guarantee these at minimal (or no) cost, then the resulting distribution can be inefficient[3]. Considerations such as these form an important part of the work of institutional economics[7]. Nonetheless, views still differ on whether something is displaying these attributes is meaningful without the information provided by the market price system[8]. The word commodity has a different meaning in business than in Marxian political economy. ... This page discusses periodic tenancies (i. ... Institutional economics focuses on understanding the role of human-made institutions in shaping economic behavior. ...


Interpretations and policy

The interpretation given above is the mainstream view of what market failures mean and of their importance in the economy. This analysis follows the lead of the neoclassical school, and relies on the notion of Pareto efficiency[4] – and specifically considers market failures absent considerations of the "public interest", or equity, citing definitional concerns[5]. This form of analysis has also been adopted by the Keynesian or new Keynesian schools in modern macroeconomics, applying it to Walrasian models of general equilibrium in order to deal with failures to attain full employment, or the non-adjustment of prices and wages. Mainstream economics is the term used to distinguish the economics profession in general from advocates of various heterodox schools, including Austrian economics and Marxian economics. ... Neoclassical economics refers to a general approach (a metatheory) to economics based on supply and demand which depends on individuals (or any economic agent) operating rationally, each seeking to maximize their individual utility or profit by making choices based on available information. ... Pareto efficiency, or Pareto optimality, is an important notion in neoclassical economics with broad applications in game theory, engineering and the social sciences. ... Public interest is a term used to denote political movements and organizations that are in the public interest—supporting general public and civic causes, in opposition of private and corporate ones (particularistic goals). ... Equity is the concept or idea of fairness or justice in economics, particularly in terms of taxation and welfare economics. ... Keynesian economics, or Keynesianism, is an economic theory based on the ideas of John Maynard Keynes, as put forward in his book The General Theory of Employment, Interest and Money, published in 1936 in response to the Great Depression of the 1930s. ... New Keynesian economics developed partly in response to new classical economics. ... Circulation in macroeconomics Macroeconomics is a branch of Economics that deals with the performance, structure, and behavior of the economy as a whole. ... Marie-Ésprit-Léon Walras (December 16, 1834 in Évreux, France - January 5, 1910 in Clarens, near Montreux, Switzerland) was a French economist, considered by Joseph Schumpeter as the greatest of all economists. He was a mathematical economist associated with the creation of the general equilibrium theory. ... General Equilibrium (linear) supply and demand curves. ... In economics, full employment has more than one meaning. ...


Many social democrats and "New Deal liberals", have adopted this analysis for public policy, so they view market failures as a very common problem of any unregulated market system and therefore argue for extensive state intervention in the economy in order to ensure both efficiency and social justice (usually interpreted in terms of limiting avoidable inequalities in wealth and income). Both the democratic accountability of these regulations and the technocratic expertise of the economists play an important role here in shaping the kind and degree of intervention. Neoliberals follow a similar line, often focusing on "market-oriented solutions" to market failure: for example, they propose going beyond the common idea of having the government charge a fee for the right to pollute (internalizing the external cost, creating a disincentive to pollute) to allow polluters to sell the pollution permits. Social democracy is a political ideology emerging in the late 19th and early 20th centuries from supporters of Marxism who believed that the transition to a socialist society could be achieved through democratic evolutionary rather than revolutionary means. ... New liberalism (also called modern liberalism or American liberalism) is a political philosophy that argues for the idea that society has the responsibility of guaranteeing equal opportunities for each of its citizens. ... Public policy is a course of action or inaction chosen by public authorities to address a problem. ... J.L. Urban, statue of Lady Justice at court building in Olomouc, Czech Republic Justice concerns the proper ordering of things and persons within a society. ... Technocracy (techno for technology and cracy for power) is an organizational system in which decision makers and political leaders are selected on the basis of technological knowledge —often because of some conflict or competition where technological escalation is a constant feature. ... For the school of international relations, see Neoliberalism (international relations). ...


Objections

See also: government failure, Austrian school, and Marxian economics

Nonetheless, many heterodox schools disagree with the mainstream consensus. Advocates of laissez-faire capitalism, such as libertarians and economists of the Austrian School, argue that there is no such phenomena as "market failures," although the notions of market efficiency and perfect competition can be redefined as to include the analytical framework of the Austrian School (praxeology). Israel Kirzner states: Government failure is the public sector analogy to market failure and occurs when a government does not efficiently allocate goods and/or resources to government consumers. ... The Austrian School, also known as the Vienna School or the Psychological School, is a school of economic thought that advocates adherence to strict methodological individualism. ... Note: Marxian is not restricted to Marxian economics, as it includes those inspired by Marxs works who do not identify with Marxism as a political ideology. ... Heterodox economics [1] refers to approaches or schools of economic thought that do not conform to mainstream economics, which has largely developed from neoclassical economics in the late 19th century. ... Laissez-faire is short for laissez faire, laissez passer, a French phrase meaning to let things alone, let them pass. First used by the eighteenth century Physiocrats as an injunction against government interference with trade, it is now used as a synonym for strict free market economics. ... Capitalism generally refers to an economic system in which the means of production are all or mostly privately[1][2] owned and operated for profit, and in which investments, distribution, income, production and pricing of goods and services are determined through the operation of a free market. ... This article does not adequately cite its references. ... The Austrian School, also known as the Vienna School or the Psychological School, is a school of economic thought that advocates adherence to strict methodological individualism. ... Praxeology is the science of human action. ... Israel Meir Kirzner (Yisroel Mayer Kirzner) (born February 13, 1930) is a leading economist in the Austrian School. ...

Efficiency for a social system means the efficiency with which it permits its individual members to achieve their individual goals[9].

The Austrian analysis focuses on the actions that individuals make, as to attain their goals or needs; inefficiency arises when means are chosen that are inconsistent with desired goals[10]. This definition of efficiency differs from that of Pareto efficiency, and forms the basis of the theoretical argument against the existence of market failures. However, providing that the conditions of the first welfare theorem are met, these two definitions agree, and give identical results. Pareto efficiency, or Pareto optimality, is an important notion in neoclassical economics with broad applications in game theory, engineering and the social sciences. ... In welfare economics, the First Welfare Theorem is that a system of free markets will lead to a Pareto efficient equilibrium. ...


In addition, economists such as Milton Friedman, often from the Public Choice school, argue that market failure does not necessarily imply that government should attempt to solve market failures, because the costs of government failure might be worse than those of the market failure it attempts to fix. This failure of government is seen as the result of the inherent problems of democracy perceived by this school and also of the power of special-interest groups (rent seekers) both in the private sector and in the government bureaucracy. Conditions that many would regard as negative are often seen as an effect of subversion of the free market by coercive government intervention. Milton Friedman (July 31, 1912 – November 16, 2006) was a prominent American economist and public intellectual. ... Public choice theory is a branch of economics that studies the decision-making behavior of voters, politicians and government officials from the perspective of economic theory, namely game theory and decision theory. ... Government failure is the public sector analogy to market failure and occurs when a government does not efficiently allocate goods and/or resources to government consumers. ... In economics, rent seeking occurs when an individual, organization, or firm seeks to make money by manipulating the economic environment rather than by making a profit through trade and production of wealth. ... The private sector of a nations economy consists of all that is outside the state. ... The Politics series Politics Portal This box:      Bureaucracy means political rule of offices. ... Coercion is the practice of compelling a person to involuntarily behave in a certain way (whether through action or inaction) by use of threats, intimidation or some other form of pressure or force. ...


Finally, objections also exist on more fundamental bases, such as that of equity, or Marxian analysis. Colloquial uses of the term "market failure" reflect the notion of a market "failing" to provide some desired attribute different from efficiency – for instance, high levels of inequality can be considered a "market failure", yet are not Pareto inefficient, and so would not be considered a market failure by mainstream economics[6]. In addition, many Marxian economists would argue that the system of individual property rights is a fundamental problem in itself, and that resources should be allocated in another way entirely. This is different from concepts of "market failure" which focuses on specific situations – typically seen as "abnormal" – where markets have inefficient outcomes. Marxists, in contrast, would say that all markets have inefficient and democratically-unwanted outcomes – viewing market failure as an inherent feature of any capitalist economy – and typically omit it from discussion, preferring to focus on what they believe to be more fundamental considerations such as class struggle or the process of commodification. J.L. Urban, statue of Lady Justice at court building in Olomouc, Czech Republic Justice concerns the proper ordering of things and persons within a society. ... Note: Marxian is not restricted to Marxian economics, as it includes those inspired by Marxs works who do not identify with Marxism as a political ideology. ... Pareto efficiency, or Pareto optimality, is an important notion in neoclassical economics with broad applications in game theory, engineering and the social sciences. ... Note: Marxian is not restricted to Marxian economics, as it includes those inspired by Marxs works who do not identify with Marxism as a political ideology. ... Class struggle is class conflict looked at from a Marxist, libertarian socialist, or anarchist perspective. ... Commodification is the transformation of what is normally a non-commodity into a commodity, to assign economic value to something that traditionally would not be considered in economic terms, for example, an idea, identity, gender. ...


See also

In economics, an externality is a cost or benefit resulting from an economic transaction that is borne or received by parties not directly involved in the transaction. ... Government failure is the public sector analogy to market failure and occurs when a government does not efficiently allocate goods and/or resources to government consumers. ... Microeconomics is a branch of Economics that studies how individuals, households, and firms make decisions to allocate limited resources,[1] typically in markets where goods or services are being bought and sold. ... Social cost, in economics, is the total of all the costs associated with an economic activity. ... The tragedy of the anticommons occurs when rational individuals (acting separately) collectively waste a given resource by under-utilizing it. ...

References

  1. ^ Bator, Francis M. (August 1958). "The Anatomy of Market Failure". The Quarterly Journal of Economics 72(3): 351-379. 
  2. ^ Medema, Steven G. (July 2004). Mill, Sidgwick, and the Evolution of the Theory of Market Failure (Online Working Paper). Retrieved on 23/06/2007.
  3. ^ a b c Gravelle, Hugh; Ray Rees (2004). Microeconomics. Essex, England: Prentice Hall, Financial Times, 314-346. 
  4. ^ a b MacKenzie, D.W. (2002-08-26). The Market Failure Myth. Ludwig von Mises Institute. Retrieved on 2007-05-30.
  5. ^ a b Mankiw, Gregory; Ronald Kneebone, Kenneth McKenzie, Nicholas Row (2002). Principles of Microeconomics: Second Canadian Edition. United States: Thomson-Nelson, 157-158. 
  6. ^ a b c d Krugman, Paul; Robin Wells, Anthony Myatt (2006). Microeconomics: Canadian Edition. Worth Publishers, 160-162. 
  7. ^ Bowles, Samuel (2004). Microeconomics: Behavior, Institutions, and Evolution. United States: Russel Sage Foundation. 
  8. ^ Machan, R. Tibor, Some Skeptical Reflections on Research and Development, Hoover Press
  9. ^ Israel Kirzner (1963). Market Theory and the Price System. Princeton. N.J.: D. Van Nostrand Company, 35. 
  10. ^ Roy E. Cordato (1980). "The Austrian Theory of Efficiency and the Role of Government". The Journal of Libertarian Studies 4 (4): 393-403. 

Year 2007 (MMVII) is the current year, a common year starting on Monday of the Gregorian calendar and the AD/CE era. ... is the 150th day of the year (151st in leap years) in the Gregorian calendar. ... Paul Krugman Paul Robin Krugman (born February 28, 1953) is an economist who has written several books, and since 2000 has written a twice-weekly op-ed column for The New York Times. ... Israel Meir Kirzner (Yisroel Mayer Kirzner) (born February 13, 1930) is a leading economist in the Austrian School. ...

External links


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