7-2

Market Failures
 5 Reason Markets Fail
1. Inadequate Competition

• Inefficient resource allocation – because no

competition
• Higher prices and reduced output
• Economic and political power → ask for tax
break and threaten to move if don’t get it.
• Not enough demand to have competition
 Market Failures

2. Inadequate Information

3. Resource Immobility – this means that

land, capital, labor, and entrepreneurs do
not move to markets where returns are
the highest. Instead they tend to stay put
and sometimes remain unemployed.
 Market Failures
4. Externalities – or unintended side effect that
either benefits or harms a 3rd party not involved
in the activity that caused it. (positive and
negative externalities).
• Externalities are regarded as market failures
because they are not reflected in the market
prices of the activities that caused the side
effects.
 Market Failures
5. Public Goods – are products that are
collectively consumed by everyone and whose
use by one individual does not diminish the
satisfaction or value available to others.
• (ex) national defense and public education. A
market fails because it cannot withhold supply
from those who refuse to pay.
 7-3
The Role of Government
 Role of The Government

• Anti-trust laws prevent or break up

monopolies, preventing market failures
due to inadequate competition.
• The Sherman Anti-Trust Act of 1890 was
enacted to prohibit trusts, monopolies, and other
arrangements that restrain competition.

• The Clayton Anti-Trust Act was passed in 1914

to outlaw price discrimination (the practice of
charging customers different prices for the same
product).
• The Federal Trade Commission (1914) was
empowered to issue cease and desist orders,
requiring companies to stop unfair business
practices.

• The Robinson-Patman Act of 1936 was passed

to strengthen the price discrimination provisions
of the Clayton Anti-Trust Act.
• Public Disclosure is used as a tool to
promote competition. Any corporation that
sells its stocks publicly is required to
supply financial reports to both its
investors and to the SEC (Securities
Exchange Commission).
• Corporations, banks, and other
lending institutions must disclose
certain information. There are also
“truth-in-advertising” laws that prevent
sellers from making false claims
about their products.
 Maintain Competition

• Sherman Antitrust Act – 1890

• Clayton Antitrust Act – 1914
• Federal Trade Commission – 1914
 Regulation

• Regulate “natural monopolies”

– State and local governments regulate many
monopolies such as cable TV, phone, electric
and water utilities.
– Companies must get approval for raising
prices.
• “Internalize externalities” – tax companies that
are causing problems in order to mitigate
problems, i.e. pollution
 Public Disclosure

• Prevent market failure due to inadequate

information
• Food labeling
• Financial information on publicly traded companies
• Loan and credit card payment accounting methods
• Support for internet and its information capabilities
• Government information available on internet
 Provide Public Goods

• Military
• Roads, airports, canals
• Schools, universities, research
• Hospitals, subsidized health care
• Water aqueducts, dams
• Old age assistance
• Parks, pools, museums
• Police, courts, prisons
• Trash collection, landfills
Modified Free Enterprise

• Encourage competition
• Regulate natural monopolies
• Require public disclosure
• Provide public goods