Market Failure, Symptoms and Reasons
A sound understanding of the economic role of the government begins with the study of private markets. We will first examine the conditions for private market efficiency, as the role of the government ends where the efficient functioning of the private markets begins.
Competitive markets are regarded to provide efficient amount of goods and services at minimum cost to the consumers who are most willing (and able) to pay for them. A perfectly competitive market is assumed to perform the following functions,
1. Rationing of supply of consumer goods among consumers on the basis of willingness of the consumers to pay and if the distribution of income is acceptable it is regarded as a socially efficient process.
2. Allocation of production between goods according to the criterion of maximum profit, which on the same assumption corresponds to social usefulness.
3. Allocation of factors of production among their various uses, according to the criterion of maximisation of their incomes.
4. Control of relative quantities of specific types of labour and capital equipment made available.
5. Distribution of income between factors of production and, therefore, between individuals.
Apart from the static functions stated above, it is considered that the free market system provides incentives for economic growth. The availability of goods through the market stimulates the consumer to seek increase in his income. The market also provides opportunity to investors of new goods and technical improvements to earn profit from their investments. In this way market helps in accumulation of material capital and human skill.
Thus, it can be seen that a properly functioning market system would tend to stimulate both economic efficiency and economic growth. But in real world, the market does not perform these functions properly and even if it does, the results produced are undesirable in themselves. Rather the market system is criticised as being either:
It is contended that the price system exists only in a rudimentary form and even if it functioned properly, the prices set by it are not a true reflection of the opportunity costs to society. The markets, especially in developing countries, are regarded to be permeated by imperfections of both structure and operation. Product and factor markets are often organised badly and the existence of 'distorted prices' means that the producers are responding to economic signals and incentives that are a poor reflection of 'real' costs to the society, of these goods and services and resources. It .5, therefore, argued that the government has to play a significant role in integrating market and modifying prices. Moreover, the failure of the market to price factors of production correctly is further assumed to lead to gross disparities between social and private valuations of alternative investment projects. In the absence of governmental interference, therefore, the market is said to lead to misallocation of present and future resources, or, at least to one which may not be in the present and future interest of resources.
It is further argued that the objectives of individual investors are not consistent with the goals of the society. The individual decisions of entrepreneurs may, lead to non-optimum allocation of resources due to various reasons as listed below.
1. Private investor maximises individual rather than social net marginal product. External economies are not sufficiently exploited. Complementarity of industries is so great that simultaneous inducement rather than autonomous coincidence of investment is called for.
2. The lifetime of equipment is very long so that investors' foresight is likely to be more imperfect than that of the buyer and seller/producer. The individual investors' risk may be higher than that confronting an overall investment programme. The costs of an erroneous investment decision are high as they have to be borne by the investor as wen as the society. Due to indivisibility of capital, large rather than small investments in capital are required.
3. Capital markets, though organised, are imperfect markets governed not only by prices but also by institutional or traditional rationing quotas.
4. It is finally recognised even by strongest advocates of a free economy that equilibrium between aggregate demand and supply (that is, dynamic monetary equilibrium) cannot itself be ensured by automatic responses of free market economy. This task can only be discharged by a deliberate economic policy. Without an equilibrium of aggregate demand and supply however prices cease to be reliable parameters of choice and price mechanism breaks down.
Free market mechanism may ensure an optimum allocation of resources in case of product and factor markets but the result may be inconsistent with the broader goals of the economy. The market does not function efficiently in case of investment and monetary equilibrium. That may not lead to maximisation of national income.
This requires interference of government to coordinate the functioning of the market system so as to assure maximisation of national income over a long period. A rational, deliberate, consistent and coordinated economic policy is required for optimum growth. In this context, a publication of UNIDO (United Nations Industrial Development Organisation) provided the following explicit "market failure" rationale for governmental intervention:
"Government cannot and should not take a merely passive role in the process of industrial expansion. Planning has to become an essential and integral part of industrial development programme, for market forces by themselves cannot overcome the deep-seated structural rigidities in the economies of the developing countries . ... In developing countries, planning is more feasible and desirable than in developed market economies. The greater feasibility is a result of the smaller number of variables that must be taken into consideration and the greater desirability stems from the fad that the automatic mechanisms for co-ordination of individual actions function less satisfactorily in developing than in developed economies. Planning in developing countries is made necessary by inter alia the inadequacies of the market as a mechanism to ensure that individual decisions will optimise economic performance in terms of society's preference and economic goals.
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