Inability to obtain optimum welfare:
We noted that under some assumptions a perfectly competitive economy in equilibrium is a Paretian optimum. Let us now examine if there are likely to be situations in practice for which all or some of the assumptions are not satisfied. In other words, in real world situation there are some situations in which it is not possible to achieve optimum welfare. The conditions to be broadly examined here one imperfections, market failure, decreasing costs, uncertainty and non-existent and incomplete markets.
Market Failure:
A market failure is a case in which a market fails to efficiently provide or allocate goods and services. In general terms, market failures are situations where market forces do not serve the perceived "public interest". The two main reasons for which it fails are (1) sub-optimal market structures and (2) the lack of internalisation of costs or benefits in prices. Examples of sub-optimal market structures include:
- Imperfect competition
- Monopoly
- Monopsony
- Oligopoly
- Oligopsony
- Monopolistic competition
- Downward sloping long run average cost curve, i.e. natural monopoly
- Price discrimination
- Price skimming
External costs and benefits
Examples of latter include:
Externality
Public goods and common property resources
- Tragedy of the commons
- Free rider problem
Uncertainty and non-existent and incomplete markets
- Asymmetrical information
- Adverse selection
- Moral hazard
- Principal-agent problem
- Market power