Essay Example on Market failure is a situation when the price mechanism Fails









Market failure is a situation when the price mechanism fails to allocate scarce resources efficiently or when the operation of market forces leads to net social welfare losses or to deadweight loss of economic welfare 1 Markets can fail for many reasons namely information failure negative externalities public and quasi public goods factor immobility and monopolies Here we will focus on monopoly power as the direct cause of market failure how it creates welfare losses and what the governments can do to rectify the failure A monopoly is a partial market failure where the market exists and functions but produces the wrong quantity of a product at the wrong price In other words it is a market dominance which leads to the underproduction and overpricing of a good than would normally exist under conditions of competition damaging the consumer welfare Theoretically a monopoly includes a single seller no close substitutes high barriers to entry and has almost complete control of the market price through manipulation of the market supply A pure monopoly occurs where there's a sole supplier holding 100 of the market shares though cases of this are rare Firms with monopoly power however are more widespread and can exist even if there s more than one supplier such in markets with two dominant firms a duopoly or with a few firms an oligopoly For regulatory purposes by the Competitions and Markets Authority CMA in the UK a firm is said to have monopoly power if it has more then 25 of the market shares For example Tesco has 30 market shares or Google 90 of search engine traffic 

2 According to Adam Smith the monopolies generally tend to seek out ways to increase their profits even at the expense of consumers and in doing so generate more costs to society than benefits 3 A monopolist has the power as a price maker as it has little to no competition in the market and will try to achieve the profit maximizing output at Marginal Cost MC Marginal Revenue MR This causes the monopoly price to be higher than the average and marginal cost of production leading to a loss in allocative efficiency The under provision and overpricing of the good causes a loss in consumer surplus and a gain in producer surplus and an overall net loss in welfare as displayed in figure 1 and 2 below Figure 1 Figure 2 Figure 1 shows a firm in a perfectly competitive market while figure 2 is the case under a monopoly In a competitive market when the firm produces at Pc it will supply a quantity of Qc where the supply curve and the demand curve meet Consumer surplus is shown as the yellow areas a b c and the producer surplus the orange areas d e Now let's consider that in the case of a monopoly as shown in figure 2 A third color grey is added to show deadweight loss the area lost from which in the competitive market was surplus to consumers or producers Consumer surplus is now area a only producer surplus areas b d and the deadweight loss areas c e Evidently going from a perfect competition to a monopoly is bad for consumers as their surplus is reduced by b c This is good for the producers however as the area b has gone from the consumers to the producers increasing the producer surplus by b e 

There is an allocative inefficiency because less output is produced due to the quantity decreasing from Qc to Qm So there is a net welfare loss when the aggregate welfare if consumers and producers are taken into account and overall society loses out Thus there is a loss of efficiency when perfect competition is taken over by a monopoly 4 Besides that monopolies are also productively inefficient as monopolists face little to no competition and thus has no incentive to reduce costs of production to the minimum This leads to possible X inefficiencies where in theory a firm could achieve average cost AC at the potential average cost curve but due to managerial slack actual AC is higher The difference between the potential and actual AC is the X inefficiency Figure 3 5 It also becomes a problem when monopolies make supernormal profits as it leads to a great inequality in income distribution in the society Besides that is speculated that due to the lack of competition and achieving supernormal profits firms are less likely to be innovative In a study by the National Bureau of Economic Research in 2017 it was found that U S businesses have invested less than expected since 2000 partly due to the lack in competition 6 An example being the cable industry who was a monopoly but because of their lack of innovation got beaten down by the disruptive technologies like Netflix and DishTV who created a new type of entertainment service which didn t require cables Furthermore a monopoly could also face diseconomies of scale if the firm grows too fast and becomes too big to coordinate properly This also contributes to the X inefficiency as there is a lack of management control causing the productivity of workers to fall

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