CHAPTER I
INTRODUCTION
1.1 Introduction
of Market Failure
A market failure is the inability of the market to
produce a desirable product or to produce a desirable product in the
"right" amount. Market failures are a common occurrence, as positive
and negative externalities yield results that are imperfect (or, at least, not
ideal) and warrant correction. We will consider several methods for correcting
allocative issues in the market and reducing the incidence of market failures. In
order to fully understand market failure, it is important to recognize the
reasons why a market can fail. Due to the structure of markets, it is
impossible for them to be perfect. As a result, most markets are not successful
and require forms of intervention.
According to K. Arrow and G. Debreu following condition must be satisfied if
markets are to yield efficient outcomes:
i)
The absence of
externalities(external economics or diseconomies that affect the activity in
question) and of public goods (commodities or services that, once provided, can
be obtained without payment by others)
ii)
The presence of perfect
completion.
iii)
A complete set of
markets, including markets extending infinitely into the future and covering
all risks.
A market failure
is said to occur where these conditions are not satisfied.
Similarly,
Market failure occurs due to inefficiency in the allocation of goods and
services. A price mechanism fails to account for all of the costs and benefits
involved when providing or consuming a specific good. When this happens, the
market will not produce the supply of the good that is socially optimal – it
will be over or under produced.
1.2 Objective
of the paper
·
To know the role of the
government in market failure.
·
To complete term paper
for fulfilment of MA Economics Degree.
1.3 Limitation
of the paper
·
Limited only on market
failure and government intervention
·
Based on secondary data
1.4
Types of Market Failure
a)
Structure
failure
The
first type of market failure is the failure by market structure. There should
be enough sellers and buyers in the market to get the beneficial effect of
competition or there should be at least the possibility of the easy entry of
new firms. Such condition is not fulfilled in some markets. The market for
water, telephone, electricity comes under this category. If a single firm,
which is called natural monopoly, can serve a particular market efficiently, it
has market power. It can earn economic profit by limiting the outputs and by
charging high price. Due to this reason the price and output of public
utilities are being regulated. From this one the one hand, the efficiency of
large-scale production is protected and on the other hand, restriction is put
on the high price and profit of the monopolist. If no efficiency is seen in
large size the antitrust policy is applied to limit the market power of the big
firms.
b)
Incentive
failure
The
second type of market failure is the failure by incentive. In the production
and consumption of goods and services social price and cost is different from
private price and cost of producers and consumers. The difference between
private and social cost and benefit is called externality. Externality is also
of two kinds.
i.
Negative
Externality: - The production, marketing or
consumption cost of the good not borne by the producers and consumers is known
as negative externality. Market failure is any situation where the allocation
of resources by a free market is not efficient. The markets are also likely to
fail to provide goods that are beneficial to society or to stop production and
consumption of harmful goods. Negative externalities have an impact on the
third parties who had no part in the transactions, but not for the consumers or
producers. Examples include second hand smoking from the consumption of tobacco
or pollution caused from production of goods. There is a negative consumption
and production externality in which in this case the consumption is of tobacco
causes second-hand smoking effects and the production causes pollution.
ii.
Positive
Externality: - Positive externality means the benefit
received from production, marketing or consumption, which is not reflected in
the price of the good. Therefore, the producers or consumers do not get
benefit. If a firm gives training to the workers, but later if they worked for
others there is positive externality. Similarly, there is positive externality
if the improvement made in the product by a firm is used by others without
compensation.
In brief,
externality makes difference the private and social cost benefit of a
particular good or activity. The firms that create considerable positive
externality without compensation do not produce in socially optimal level. On
the other hand, the firms that create negative externality do not pay full cost
of their activities and usually produce more than the level where social
benefit is maximize.
In
this way, since market imperfection or market failure does not give the signal
of appropriate cost and benefit the government should play an active role in
the economy.
Environmental concerns: effects
on the environment as important considerations as well as sustainable
development.
Public goods: public
goods are goods where the total cost of production does not increase with the
number of consumers. As an example of a public good, a lighthouse has a fixed
cost of production that is the same, whether one ship or one hundred ships use
its light. Public goods can be under produced; there is little incentive, from
a private standpoint, to provide a lighthouse because one can wait for someone
else to provide it, and then use its light without incurring a cost. This
problem - someone benefiting from resources or goods
and services without paying for the cost of the benefit - is known as the free rider problem.
·
Underproduction
of merit goods: a merit good is a private good that society
believes is under consumed, often with positive externalities. For example,
education, healthcare, and sports centres are considered merit goods.
·
Overprovision
of demerit goods: a demerit good is a private good
that society believes is over consumed, often with negative externalities. For
example, cigarettes, alcohol, and prostitution are considered demerit goods.
When a market fails, the
government usually intervenes depending on the reason for the failure.
Chapter II
Subject Matter
2.1Role
of the government
in order to response market failure
The Role of the government response
on market failure or action can be divided into two parts:
i.
Regulatory
Response to Structural Failure:-
Monopoly
or oligopoly limits output and earns abnormal profit. The harmful consequence
occurs in the society due to such structural failure. Hence, to reduce or to
remove such evil consequences the government controls the monopoly. The
regulation of public utilities is an example of it. The tax and antitrust
policies are also the policies to remove structural failure. These policies
limit the wrong tendency of the monopoly.
A
monopoly firm may earn more profit by producing very lower output. Therefore,
two methods are used to control the monopoly situation:
a) Control Over Industry
Structure
The
antitrust laws designed to reduce industrial concentration and prevent
coalition between oligopoly firms is the primary example of such control.
b) Direct Controls
The
direct Control is imposed to prevent the monopoly industries from taking undue
benefit from their customers. The regulation of public utilities is an example
of this kind of control. In this method price is determined at the level of
preventing the firms from earning monopoly profit.
ii.
Regulatory
Response to Incentive Failure:-
This
method includes subsidy, taxes, operating right grant, and patent. These
methods are widely used. The government uses both subsidy and tax policy to
reduce the market failure due to incentive failure. When there is positive
externality the government uses patent and subsidy to reward the activity
having such externality. The government imposes taxes as the negative subsidy
and makes provision of requiring operating right to limit the negative
externalities.
The
forms of regulation under regulatory response to incentive failures are patent
system, subsidies, operating controls, operating right grant, tax policies and
regulation of environmental pollution.
-
Patent system
-
Subsidies
-
Operating Controls
-
Operating Right Grants
-
Tax policies
2.2
Remedial
measures adopted by Government
The
government adopt various measures to prevent the market failure. Some of the
measures are discussed below:
i.
Direct
Regulation: - The
first and foremost method used by the government to make the business firms
reduce pollution is direct regulation of direct ban on production activity. For
example, the government may order the firms to limit pollution up to level B or
fixes pollution standard. On this very basis the import of car, tempo, and
motorbike, etc. have been banned in Nepal. Alternatively, the government may
fix the emission standard. The vehicles that do not fulfill stipulated criteria
have been banned from entering certain areas of Kathmandu. The individuals or
firms violating this order of the government are subject to fine penalty.
ii.
Effluent
fee or pollution tax: - Policies based on
incentives are known as market-based policies. Pollution fee tax, tradable
permits are examples of it. Market based instrument are best in principle and
often in practice. They encourage those polluters with the lowest costs of
control to take the most remedial action. The Government encourages the firms
to reduce pollution also by imposing effluent fee. According to Edwin
Mansfield- “An effluent fee is a fee that a polluter must pay to the government
for discharging waste.”
iii.
Issue
of Transferable Emissions permits: - The
government may reduce the quantity of pollution also by issuing transferable
emissions permits. Such permit allows creating pollution in given quantity.
Such permits are being issued in limited quantity. When this is done the total
quantity of population is equal to one determined by the government. The
permits of limited number are distributed among the firms.
iv. Evaluate
the measures that a government might adopt to correct market failure arising
from negative externalities.
v.
The measures that a
government might adopt to correct market failure arising from negative
externalities which include legislation, regulation, taxation and
advertisement. Taxation is placed on the products which produce negative
effects on the third party as it would increase the price of the product and
decrease demand. The decrease in the demand by consumers of, for example
cigarettes, will most likely have a decline in the consumption. Yet, there are
anomalies of people who still consume these products even due to the taxation.
Placing taxes or by increasing the tax, may continue to maintain the revenue of
the cigarette as there is always a group of people who are addictive to these
inelastic goods. Also, the rich will be willing and able to buy the high priced
products, which would maintain the income of producers, yet could decrease the
consumption. By correcting these market
failure arising from the negative externalities, it would enable the government
to increase their health of the country as well as the environment. With a
improvement in both the health and environment of the country, governments
could be beneficial economically as they could gain wealth as health care will
decrease.
Chapter
III
Summary
and Conclusion
3.1
Summary and Conclusion
The
role of government is vital in case of market failure. In case of Nepal
government try to address the market failure through different policy
formulation and implementation but due to poor implementation of policy the
government effect is unfruitful. Beside that there is no anti-trust policy in
case of Nepal which is vital to address monopoly power reduction of firms and
encourage competition in the market. Beside there is existence of cartel in
different sector which is not properly control by the government of Nepal.