Question: Discuss the causes of market failure and how the government can

intervene to correct market failure?

Market failure is the inability of a market or system of markets to provide goods and services
either at all or in an economically optimal manner. (Dollery and Wallis, 2001). Furthermore, the
individual incentives for rational behavior do not lead to rational outcomes for the group. Put
another way, each individual makes the correct decision for him/herself, but those prove to be
the wrong decisions for the group. In traditional microeconomics, this is shown as a steady state
disequilibrium in which the quantity supplied does not equal the quantity demanded. There are
several reasons as to why a market can fail, the following are some of the causes;

Externalities: Externalities are one of the classic cases of market failure, which relate
to how the activities of economic agents impact other agents that are excluded from the
transaction or operation, but however ends up suffering (incurring social costs) or benefitting
(social benefits). In this context, the producers of the costs or benefits neither incur the social
costs nor receive the social benefits. Externalities lead to market failure by inefficiently
allocating resources, on the basis that market prices do not capture the social costs involved in
production and hence will not attain socially efficient levels of consumption and production.
Public Goods: Public goods are goods that are consumed by a large number of the
population, and their cost does not increase with the increase in the number of consumers. Public
goods are both non-rivalry as well as non-excludable. Non-rivalry means that the goods are
allocated efficiently to the whole population if provided at zero cost, while non-excludable
means that the public goods cannot exclude non payers from its consumption. Public goods
create market failures if certain buyers that consumes goods failed to pay but continues using the
goods as actual payers.
Imperfect information: Market failure may also be caused by imperfect information
among buyers and sellers. Because of the lack of appropriate information the price of goods and
services may not be the actual price in the market. The lack of information to the buyers’ side
may mean that the buyers may be willing to pay a higher or lower price for the product because
they don’t know its actual benefits. As for the sellers side, lack of information may mean that
they may be willing to accept a higher or lower price for the product than the actual opportunity
cost of producing it.
 Market Situation: The situation of the market can also be a reason for a market
failure. In here we will look at who has the power to control the determination of the price of
goods and services in the market, is it a buyer or a seller. The power prevents the natural forces
of demand and supply from setting the prices of goods and services. If the market is comprised
by a single buyer or a few buyers while there are many sellers, the buyers may exercise their
dominance by colluding to set the price at which they are willing to buy the products from the
producers. On the other side, if the market is comprised with single or few sellers and many
buyers, the sellers may collude to set higher prices to maximize their profits.
Apart from the causes of the market failure, there are the measures in which the
government can intervene to correct the market failure situation. The following are those
measures;
Taxation: Tax are compulsory payment imposed by the government on individual
and firms. It is known that taxes are the main source of the government revenue. Apart from
generating revenue, taxes can also be used by the government to stabilize the economy. A tax is
one among the measures used by the government to control market failures. The government
through imposition of indirect tax to the products that cause negative externalities and harm to
consumers can correct the market failures. For example, a government can increase taxes on
cigarettes and alcohol to discourage their consumption and reduce their harmful effects on
unrelated parties.
Subsidies: Subsidies are payment made by the government to producers or
consumers to encourage production or consumption. Through subsidies a government can also
be able to correct market failure. A government may provide subsidies to the producers who
produce the goods that have positive externalities so as to correct market failures. For example a
government lowering the college tuition so that the society can benefit from educated workers.
Property rights: In order to deter or limit the abusive utilization of publicly
accessible goods or services like lakes, forest and sea front / beaches, government as a central
authority may need to establish some level of privatization measures of these named publicly
utilized assets to continue their usage for both present and future generations. In this case, market
failure can be prevented by levying fines to make sure the environment is not overly depleted at
the expense of the present and future generations.
 Legislative measures: The government can also intervene the market failures by
the use of legislative measures. This may include the enactment of laws to prevent big
monopolistic firms from restricting smaller firms to enter a product market. In this type of
situation, it means that such big monopoly establishments can be at liberty of setting outrageous
prices, which are mostly out of range for low income earners. Smaller firms can strive to gain
access into a market as new entrants, with production devoted segregating commodities, thereby
creating opportunities for decent standard of living for low income earners. The enactment of
legislations can be extended widely to cover anything that seeks to derail a progressive or
sustainable society, more so in ensuring that resources are judiciously utilized in the best interest
of citizens rather than favoring those considered to be in the elite group.
REFERENCES
Introducing Market Failure |Boundless Economics. (n.d.). Lumen Learning. Retrieved December
21, 2021, from
https://courses.lumenlearning.com/boundless-economics/chapter/introducing-market/failure/
Corporate Finance Institute. (2021, January 30). Market Failure. Retrieved December 20, 2021,
from
https://corporatefinanceinstitute.com/resources/knowledge/economics/market-failure/