Essay About Market Failure Graph

The Effects of Market Failures Essays

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The Effects of Market Failures

Innovation has a crucial impact on the standards of living in particular economy. It is generally agreed that research and innovation are the main sources of growth and job creation in market economies. i.e. output is increased through greater acquisition of knowledge. Subsequently, 2 things matter for economic growth: savings and the state of the productive knowledge (i.e. shows how productivity the extra capital will be used). The production function diagram below can illustrate this



Where labour productivity per worker experiences diminishing marginal returns

This diagram shows how economic growth can be realised by…show more content…

A general consensus states a positive incidence of technological progress on growth, competitiveness and employment. Enormous amounts of money are spent on innovation and studies reveal that the economic return on innovation is very high in relative terms. Reviewing the diagram on returns to innovation below can see this.




The demand curve indicates the marginal valuations of this particular product and it is assumed that a single monopoly supplier produces the goods with constant marginal costs – c and sets prices above marginal costs at P. The private rate of return is B as the firm exploits its product and receives a private rate of return extended over time against the cost of innovation. The social rate of return is larger as it is the sum of the private return and consumer surplus i.e. (A+D). Better measures can be seen empirically as Nadiri (1993) concluded that the private return on innovation was usually around 20 to 30% and the average social return close to 50%.

This begs the question, why are such less resources devoted to innovation even though the rate of returns to society is so high? There are many reasons to this, which I shall discuss later, but crucially it depends on the view of markets and competition. There are 3

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When markets fail, public policy may remedy the problem and increase efficiency. In connection to the above statement, discuss the implications of the implementation of the different forms of public policy. Your answer should be supported with suitable examples, evidences and diagrams.

A market is defined as the buyers and sellers of a particular good or service. There are many different types of market. For example, there are currency markets, stock markets, commodity markets and many more. Ultimately, we would like to achieve a market which is in equilibrium, whereby the market price of a goods or service reaches a level where quantity supplied matches the quantity demanded. However there are many instances when failure of market occurs, this represents ineffective allocation of the scarce resources when left on its own. When failure of market takes place, government intervention will be greatly needed. It could come in the form of public policies or rules and legislation.

An example of market failure would be externalities. An externality is the impact of the activity of one person on the bystander, and externality can be further divided into positive or negative production and consumption externalities. Environment pollution emitted by companies is an example of negative production externalities. I will use the supermarket, Tesco as an example. The supply curve represents the private costs to Tesco for producing a given amount of good. The more goods they produce, the higher the cost is. Ideally, the price perceived by the producer must be able to cover the cost of production and during the process, achieving the marginal profit that will allow them to sustain and survive in the market. During the everyday business, Tesco emits air pollution through the delivery trucks that send the stocks to Tesco or during the process of food production. Tesco also contributes to food wastage as they are among the supermarkets found to be rejecting apples purely on cosmetic grounds (Friends of The Earth, 2002). Pollutions cause a negative externality on the bystanders. To solve this problem, the government imposed pollution tax on Tesco. This increases the social cost while allowing a socially efficient output by the producers. Although the tax was meant to be imposed to punish Tesco for their negative actions, the tax is actually being borne by the consumers and the producers. The graph shows that if we as humanity wish to minimize the damage to the environment, we have to be prepared to pay a little more to enjoy the benefit (Biz/ed, 2003). The impact is greater on the consumer as the goods sold by Tesco are generally necessities. Resulting is an inelastic demand for goods. But in the long-run, the producers will be shouldering the burden as the consumer can buy similar goods from other supermarkets. Demands for goods will be elastic. Illustrations from the graph from show the effects.

Underproduction of education services is also a form of market failure. However education generates positive production externality and positive production externality exists when the social benefit is greater than the private benefit. An example of a production positive externality is education. Why does education provide positive externality? This is because it is an important determinant of economic growth and it is also associated to non-economic benefit such as better health and mind. It is a long term investment for a country. We shall be looking at Malaysia's education. Due to the inability of the education institutions to earn higher profit margin, the quantity of education institutions remains below the optimum quantity. To solve this problem, the government provides subsidies on education. The graph is shown below:

It comes in the form of scholarship opportunities or budgets provided by the country, in fact for Malaysia Budget 2010, the country has allocated RM30 billion to enhance the education experience. Besides, they government have also heavily subsidised the primary and secondary education to provide free education to all the citizens of Malaysia. The subsidies will increase the quantity of education institutions and makes education more affordable to the society.

Market failure also happens because of inequality throughout the economy. Inequality can strike on living standards, purchasing power or the distribution of income. When the government recognises problems like these, they will apply specific controls to recuperate the economy. One of the controls is called the price ceiling control. A price ceiling occurs when the price is artificially set at below the equilibrium price and it is not allowed to rise. An example for price ceiling would be the rent control. We shall take the rent control in New York as an example. It was being implemented by the federal government to help out the low-income citizens. The rent control is based on the Maximum Based Rent System. Usually the rent control will cause a shortage of supply of apartments to rent, as the demand for apartments is greater than the supply of apartments. In an unregulated market, the normal behaviour of the market would be to increase the price of the apartments. However the price ceiling prevents it from doing so. The graph is shown below:

Thus methods of rationing must be developed by the government. The normal method is the first come, first servedwhere people will queue in a long line to purchase a vacant apartment of their choice. Otherwise the seller's practices discriminationwhereby they can choose their renters according to their preference, or the government will allocate the choices to the buyer themselves. However due to desperation, buyers would do whatever it takes to secure the limited amounts of apartments available. Hence black markets are formed and they sell the apartments at a significantly marked up price to the desperate buyers. This will cause a loss to sellers and buyers gains from it. Instead of giving rent-controlled apartments to the needy, we can consider giving them additional income and let them decide what they want to do with it. Detailed background checks should be done to ensure that the needy ones are receiving the financial assistance. We should also let the renting price of the apartment to float, allowing it to be manipulated by the supply and demand of the market. Since imposing ceiling price will create shortages instead of solving the market problem.

The other control is known as the price floor control or also known as price supports. A price floor occurs when the price is artificially set above the equilibrium price and it is not allowed to go below it. This type of price control requires the government to become an active buyer in the market. An example of it is the price floor of the cigarettes set by the Malaysian government on the 1st of January 2010 (in The Star 29 December 2009). This is usually sustained for private businesses to conduct their fair trade. It is especially important for the cigarette and tobacco industry as they face fierce competition from their counterparts in the form of contraband cigarettes. The price is set adequately high so that the tobacco sector still can earn their share of income to ensure their survival. However price floors' also creates surpluses whereby supply of cigarettes is greater than the demand of it.

Some of the ways to handle this issue is to have the supplier themselves to absorb the surplus, they can recall the unused cigarettes to recycle. Another way to handle it would be to re-sell the cigarettes with a different name, so that the losses incurred by the producers will be minimized. Price floors' may seem biased towards the tobacco industry that are generally perceived as an “unhealthy” industry to the public, but it can also help out the society in some ways. The price (RM6.40) which is higher than the equilibrium price (RM4.50) is hoped to be able to deter the use of tobacco among the younger generation and helping them to recover from their addiction. Figure quoted from (Bernama29 October 2008).

In conclusion, an inefficient market can be corrected by the intervention of the government. Subsidies, taxes and many more are public policies that can be used to solve market failure. However caution must be given to the government to abstain from doing anything when the market is efficient. Examples are shown that when price ceiling are being introduced in the form of rent control, it will not solve the market failure In fact the situation may become even worse off. Hence public policies can remedy and increase efficiency of the market when they are implemented correctly.

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