MARKET FAILURE

In a perfectly competitive market economy, most decisions are made in markets where buyers and sellers determine prices and quantities for goods. Adam Smith, the founding father of economics, said that the invisible hand of markets lead to the optimal economic outcome as individuals pursue their own self-interest. In pursuing his own interest, he unwittingly promotes that of society. However, markets do not always lead to the most efficient outcome MARKET FAILURES An imperfection in the market (or price system) that prevents an efficient allocation of resources. Ex. Imperfect competition; Externalities; and Uneven income distribution
Market Failure 1

IMPERFECT COMPETITION
- If a firm appreciably affect the market price of its output, the firm is classified as an imperfect competitor. - IMPERFECT COMPETITION prevails in an industry whenever individual sellers have significant or some measure of control over the price of their output. (However, it does not imply that a firm has absolute control over the price of its product.) - Imperfect competition produces high prices and inefficient/low levels of output. - To control these conditions, government regulates businesses or put legal antitrust constraints on business behavior.
Market Failure 2

MONOPOLY
A single seller with complete control over an industry From the Greek word mono for one and polist for seller The only firm producing in its industry, and there is no industry producing a close substitute PURE Monopoly In the long run, no monopoly is completely secure from attack by competitors Example: Meralco, San Miguel Beer

OLIGOPOLY
Means few sellers; few, in this context, can be a number as small as 2 or as large as 10 or 15 firms Each individual firm can affect the market price for the number of sellers to be stable, there must be some barriers to entry of new competitors Ex: breakfast cereals (there are many varieties of cereals but only few producers.) ; softdrinks market
Market Failure 3

Monopolistic Competition
There is large number of sellers producing differentiated products This market structure resembles perfect competition in that there are many sellers, none of whom have a large share of the market. It differs from perfect competition that the product sold by different firms are not identical. DIFFERENTIATED PRODUCTS are ones whose important characteristics vary Entry is free Example: personal computers (computers differ in speed, size, memory, repair services, and ancillaries like CDs, DVDs, Internet connections, and sound systems.)
Market Failure 4

 Monopoly
Natural Monopoly
There are some industries like power production or water distribution which require large sums of capital that for them to make reasonable profit, they have to cover a large amount of area/population. Thus government allows them to be a monopoly for that area.

Their products usually have an Inelastic demand. That is, if its price changes, the effect on Quantity Demanded is minimal.
The demand curve is Downward-sloping but STEEP Role of Government
5

 Monopoly: How do they increase prices and what happens after? It reduces output. With a shift of the supply curve to the left, at the old equilibrium price, there will be a new Quantity Supplied that is less than the Quantity Demanded, thus, creating a shortage. This shortage will cause Price to increase to a new equilibrium point with new Eq. Price and Quantity. With a steep demand curve, this new price would cause the monopolists Total Revenue to go UP This gives the monopolist higher Profits.
Role of Government 6

Perfect
Competn

Monopolistic Comptn

Oligopoly

Monopoly

Nearly Infinite Control No over Price Control Barriers to None

Entry

# of firms

Many Few Com- One Competitors petitors

Some Some

Large High

Most Significant

Very High

Product
Price

Homogenous Equilibri um Price

Highly Differentiated Penetration Pricing

Market Failure

Differentiated

Any

Price War or High Collusion Prices

7

SOURCES OF MARKET IMPERFECTION

2 PRINCIPLES CAUSES of MARKET IMPERFECTION 1. Industries tend to have fewer sellers when there are significant economies of large-scale production and decreasing costs 2. Because of barriers to entry that make it difficult for new competitors to enter industry. In some cases the barriers may arise from government laws/regulations which limit the number of competitors. In other cases, there may be reasons why it is simply too expensive for a new competitors to break into a market.
Market Failure 8

BARRIERS TO ENTRY
Factors that make it hard for new firms to enter an industry. When barriers are high, an industry may have few firms and limited pressure to compete. TYPES OF BARRIER TO ENTRY 1. LEGAL RESTRICTIONS - governments sometimes restrict competitions in certain industries ex. PATENT- granted to an inventor to allow temporary exclusive use ( or monopoly) of the product or process that is patented.
Market Failure 9

ENTRY RESTRICTIONS - utilities, such as telephone, electricity and water, are given franchise monopolies by Congress to serve an area IMPORTANT RESTRICTIONS - its effect is keeping out foreign competitors in the country. 2. HIGH COST OF ENTRY - the amount of investment required to enter the market is very high. i.e. high investment costs to put up a TV station 3. ADVERTISING & PRODUCT DIFFERENTIATION - sometimes it is possible for companies to create barriers to entry for potential rivals by using advertising & product differentiation
Market Failure 10

Cost & Market Imperfection

The technology and cost structure of an industry help determine how many firms that industry can support and how big they will be. If there are economies of scale in an industry, it can decrease its average costs by expanding its output, at least up to a point. That means bigger firms will have a cost advantage over smaller firms. *Economies of scale - arises when an increase in all inputs lead to a more-than-proportional increase in the level of output
Market Failure 11

EXTERNALITIES
Externalities - the second type of market failure occurs when economic activities bestow benefits (+) or impose costs (-) on others without them paying or being compensated by the market It is the impact of one persons actions on the well-being of a bystander. The side effects of production or consumption are not included in market prices. Positive Externalities Beneficial externalities; activities that lead to the well-being of third parties without them paying for it. Ex. Scientific discoveries; parks; security guards
Market Failure 12

Negative Externalities Activities that imposes costs to third parties without them being compensated for it. Ex. Pollution/environmental noise & health costs

UNEVEN DISTRIBUTION OF INCOME

The market economy rewards people according to their ability to produce things other people are willing to pay for. The invisible hand does not ensure that everyone has sufficient food, decent clothing & adequate health care.

GOVERNMENT INTERVENTION
To improve on market outcomes regulate pollution; provide public goods; use minimum wage policy; impose taxes for welfare programs
Market Failure 13