As we can see in the previous video ( consumer and producer surplus) the concept of consumer and producer surplus. In case of market failure ( monopoly) the price P is not at the point where the demand and supply curves intersect instead it is at the point much higher. Leading to the dead weight loss.
1. Failure of Competition
If there is single producer, one of the conditions for perfect competition (large number of buyers and sellers) is violated. With monopoly pricing (and other forms of imperfect competition in which each producer has some influence on price) output can be less than competitive market equilibrium output, and price higher than the price under perfect competition.
Monopoly Pricing
2. Public Goods
Pure public goods have two properties:
(1) There is no additional cost in providing the good to one more person (good is non-rival)
(2) It is difficult or impossible to exclude individuals from the enjoyment of public goods (non-excludability)
With public goods there will be free riders who can enjoy the public good without having to pay for it. If all individuals were to reveal their true demand curve, everyone could be charged the price for the public good according to the valuation they place on the good. But public goods allow for free riders who will understate the value they place on the good. The private market decides on the basis of benefit that can be captured. The benefit of public goods cannot be entirely captured by the producers of these goods and therefore the good may not be supplied at all or too little quantity of the good may be supplied.
3. Externalities
Private costs and social costs may differ. A producer takes into account only private cost and not the costs that it may incur on others as part of the production process, e.g., industrial emissions or exhaust fumes of trucks and buses. The perfectly competitive model assumes absence of such externalities and no difference between marginal private cost (MPC) and marginal social costs (MSC). Externalities can be negative and positive . If these costs are factored in, the MSC may lie above or below the MPC. As a result the socially optimum output may be less than or greater than competitive market equilibrium output. There can be similar positive or negative externalities on the demand side so that social valuation placed on a good may be different from private valuation.
4. Incomplete Markets
When private markets fail to provide a good or service even though the cost of providing it is less than what individuals are willing to pay, it is a form of market failure referred to as incomplete markets. Farmers may be are unable to cover their risk against poor harvest or banks may not be able to insure the risk of default on their loans. When markets are incomplete the government may have to step in.
5. Incomplete Information
Consumers may have incomplete information about the goods they purchase, e.g. information on new drugs or second hand cars. Without this information consumers will very likely make incorrect buying decisions. The perfectly competitive model assumes that all relevant information is freely available to consumers. The role of the government for greater disclosure is considered essential for consumers to be able to value a good correctly. Information is at times like a public good – non-rival and non-excludable, e.g. information related to weather or early warning of floods. With information which is in the nature of public goods, private sector will under-provide such service, if at all.
6. Economic Stabilization
Market failure can occur when price signals are not operating effectively to clear the markets. The economy can be stuck in long periods of recessions with unemployment and output losses resulting in prolonged periods of suffering for those unable to find work. Governments can use monetary and fiscal policies to stabilize the economy.
Reference
Joseph E. Stiglitz; Economics of the Public Sector, third edition; W.W.Norton and Company, New York, 2000
