30 - PROBLEM AREAS FOR THE MARKET

Abstract

This chapter discusses the problem areas of the market. The sources of market failure can be grouped into four categories, namely, externalities, public goods, poor information, and monopoly. When externalities are present, the market may fail to confront decision makers with the proper incentives. Because the decision makers are not forced to consider external cost, they may find it advantageous to undertake an economic activity even though it generates a net loss to the community. When external benefits are present, the decision makers may fail to undertake economic action that would generate a net social gain. When external costs originate from the activities of a business firm, the firm's cost curve would understate the social cost of producing the good. If production of the good generates external costs, under competitive conditions, the price of the product would be too low and the output would be too large relative to the ideal requirements of economic efficiency. External costs result from the failure or inability of a society to establish private property rights. Established private property rights enable owners to prohibit others from using or abusing their property. Communal property rights result in overutilization because most of the cost of overutilization is imposed on others. When external benefits are present, the market demand curve would understate the social gains from conducting the activity. The consumption and production of goods that generate external benefits would tend to be less than the socially ideal amount.