Market Failures: Competition, Externalities, and Public Sector
Failure of Monopoly and Competition
Another argument that justifies public sector intervention in the economy is the warranty of competition. Markets can only allocate resources efficiently when buyers and sellers act in perfect competition. This means many suppliers and consumers produce and consume the same good, and, more importantly, none of them have special control over the price. When the market deviates from perfect competition, there is a failure in competition.
Factors Limiting Competition
Many circumstances may limit competition and lead to monopolies, oligopolies, or monopolistic competition. Economies of scale assume that the larger the production plant or volume, the lower the average cost per unit. Thus, a large firm with high production volume has advantages over small firms. In this situation, monopolies emerge naturally, spontaneously, and due to sector technical characteristics. One or two companies can control the entire industry output.
The Problem of Competition Failure
The problem of competition failure is that monopoly firms set prices, not taking market data into account. Prices in these markets tend to be higher than socially optimal prices, which is higher than in a perfectly competitive market, adversely affecting society. Therefore, if there are issues in competition, the public sector can intervene to ensure competitive conditions or, at least, try to keep prices close to those in perfect competition. This can be done through direct control of natural monopolies, which would become public sector property, or by regulating and posting these prices, which will necessarily affect property on the market.
Definitions
- Monopoly: A market situation where the supply of a good is reduced to one producer, enabling control over its price.
- Oligopoly: A market situation where the supply of a good targets a few businesses, enabling control over its price.
Externalities
An externality occurs when an individual performs a task that affects another’s welfare, and neither pays nor receives compensation for these effects.
Negative Externalities
Negative externalities occur when an individual’s actions impose a cost on other operators without the individual paying for that cost. The problem is that the cost to the individual creating the negative externality is less than the social cost of their actions. To improve overall efficiency, the public sector must limit these negative externalities. This can be done through several alternatives: taxes or sanctions for causing negative externalities, or, continuing the environmental theme, prohibiting or limiting the amount of pollutant emissions allowed to each company.
Positive Externalities
Positive externalities occur when an individual’s action or activity benefits the rest of the economy without compensation for the beneficial effect. The problem with positive externalities is that, while individual benefits are less than social benefits, the private market tends to produce too little of the goods that generate positive externalities. To solve this defect and promote education, research, and other activities generating positive externalities, the public sector intervenes in the market, often by awarding grants to minimize costs and boost private production of activities involving positive externalities.