Imperfect market externality:

We will be  able  to obtain optimum welfare  in  competitive market  conditions through  economic reorganisation. But the  real life conditions do not  always exhibit the competitive features of  the market  owing to some  constraints. Therefore, we are unable  to attain optimum welfare.  In  this  unit,  we  will examine these conditions, which lead to market failure and inability to obtain optimum welfare  in  the society. We  shall  also discuss the  phenomenon of externality, which  is peculiar to the consumption of public goods.  The competitive market provides an efficient outcome.  However, we  face to imperfect markets, information  asymmetry, externalities  and presence  of public goods, which contribute to non-attainment of  such a position. In case imperfect  competition, price  and marginal cost equality required for Pareto optimality is violated. Again, between a pair of goods, the  ratio of shadow price is not equal to their ratio of market price.

Externalities give rise to market  inefficiencies whereby  the consumption and production  quantities do  not  match., Pollution is  a  common  example  of externality, where market  fails to  provide solution.  It  necessities collective solutions such  as government intervention. When  there  is  uncertainty about costs and benefits, shapes of marginal cost and marginal benefit may have  to be taken into account for adopting one of the collective solutions.

Inefficiencies  due to market failure may be tackled through bargaining among the affected parties. Coase theorem offers a solution to include clearly defined property rights, when transaction costs are zero. Public goods,  because  of their  non-rival  or  non-exclusive features,  are  not produced efficiently  by  the market. To bring in efficiency to public goods provision, the vertical sum of the individual demands must be made equal to the marginal cost of their production.