19 - PROBLEM AREAS FOR THE MARKET

Abstract

This chapter focuses on market failure, economic activity that results in allocative inefficiency relative to the hypothetical ideal of economists. The sources of market failure are grouped into four general classes: (1) externalities; (2) public goods; (3) conflicts between buyers and sellers after an exchange, stemming from poor information and misrepresentation; and (4) monopoly. Market failure creates an opportunity for government to improve the situation. However, in some circumstances, public sector action is not corrective. Sometimes there may even be good reason to expect that it will be counterproductive. The chapter describes external costs and external benefits of a market exchange system. When production and exchange affect the welfare of nonconsenting secondary parties, externalities are present. The external effects may be either positive or negative. If the welfare of nonconsenting secondary parties is adversely affected, the spillover effects are called external costs. If the spillover effects enhance the welfare of secondary parties, they are called external benefits. When external costs and external benefits are present, market prices will not send the proper signals to producers and consumers. This situation results in market failure.