Paper

“” MARKET FAILURE “”

By :

Yulia Dwi Putri

2110512007

Lecture : Dr. Hefrizal Handra, M.Soc.Sc

Indah Maya Sari, SE, M.Si

Economics of Public Sector

Departement of Economics

Faculty of Economics and Business

Andalas University

2022
 PREFACE
First of all, thanks to Allah SWT because of the help of Allah, writer
finished writing the paper entitled “”an economic scientific paper “” right in the
calculated time.

The purpose in writing this paper is to fulfill the assignment that given by
Dr. Hefrizal Handra as lecturer in Economics of Public Sector course.

In arranging this paper, the writer trully get lots challenges and
obstructions but with help of many indiviuals, those obstructions could passed.
writer also realized there are still many mistakes in process of writing this paper.

Because of that, the writer says thank you to all individuals who helps in
the process of writing this paper. hopefully allah replies all helps and bless you
all.

The writer realized that this paper still imperfect in arrangment and the
content. Then the writer hope the criticism from the readers can help the writer in
perfecting the next paper. Last but not the least hopefully, this paper can helps the
readers to gain more knowledge about Market Failure as economic thinking.

Padang, October 20, 2022

Writer

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 TABLE OF CONTENT
PREFACE.................................................................................................................i
TABLE OF CONTENT...........................................................................................ii
CHAPTER I (INTRODUCTION)
A. Backround.....................................................................................................1
B. Formulate Of The Problem...........................................................................2
C. Aims Of Paper...............................................................................................2
CHAPTER II (THEORITICAL STUDY)
A. Definition Of Market Failure........................................................................3
B. Definition of Government Intervention........................................................5
CHAPTER III (RESULT AND DISCUSSION)
A. Maeket Failure .............................................................................................7
B. Government Intervention...........................................................................12
CHAPTER IV (CONCLUSION)
A. Conclusion..................................................................................................15
B. Suggestion...................................................................................................16
BIBLIOGRAPHY

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 CHAPTER I

INTRODUCTION

A. Backround
Economy of the country cannot be separated from the government
interference and market mechanisms that occur. The government has a degree
of influence that vary from the economy. There is a strictly regulating
government, there is also restricting and only working as a supporter in the
economy a country.
The role of the government in the economy is carried out through econo
mic activity by carrying out the functions of allocation , distribution and stabili
zation . Through such activities , resources what are available can be processed 
and utilized by every human being through the form of goods and services
through market activities or mechanisms. Through a tug-of-war on market
mechanisms in any process of economic activity, everything will go towards
equilibrium a market that is reflected by the creation of well-being and justice
. So that it can it is concluded that justice and welfare are the ultimate goal in a
economic activity.
However , in reality the market balance is very difficult to achieve or
occur market failure, that is, the condition that the market mechanism does not
function efficiently as allocating existing economic resources to the
community. This causes the goods produced to be too much or too little, and in
very extreme circumstances it will cause the market not to occur so that certain
goods and services are not produced by that market. The essence of the
emergence of market failures because the community does not act
cooperatively, because it is this cooperative behavior that will cause the Pareto
Optimal condition. ( Mangkoesoebroto , 1999 in Mansjur , 2005) .
The economic system will never be perfect in essence. There is not a
very appropriate system for a country, due to its dynamic changes also the
worldwide influence of globalization. The purpose of writing this paper is to

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 knowing what are the factors causing market failures and intervening measures
government to address it.
In this case , the occurrence of market failures demands government
interference in maintaining the stability of market mechanisms . The role of the
government in the economy is to reduce the impact on market failures, so that
the allocation of economic resources can be achieved efficiently .

B. Formulate Of The Problem

1. What is a market failure?
2. How can market failures occur?
3. How the government intervention in overcoming market failures that
occur

C. Aims Of Paper
The aim of this paper is to understand in depth the meaning of market
failure, what causes market failure and economic thinking about government
intervention in overcoming market failures.

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 CHAPTER II

THEORITICAL STUDY

A. Definition Of Market Failure

According to Gilarso (2004: 154), the market is a place where buyers and
sellers meet to buy and sell goods. While Miller and Meiners (2000 : 23),
stated the market in the broad sense that a market does not have to be a place,
but an institution upon which the forces that determine prices operate, in other
words it is in the market that supply and demand operate. So it can be said that
the market is a mechanism, not just a place that can organize the interests of the
buyer to the interests of the seller. The mechanism is not only understood as a
way for buyers and sellers to meet and then separate, but more than that it is
interpreted as an order of various parts, namely actors such as buyers and
sellers, commodities traded, written and unwritten rules of the game agreed
upon by the perpetrators, as well as government regulations that are
interrelated, interacting and simultaneously moving as a system.
In its mechanism, the market has three functions, namely the distribution
function, the formation function price and promotion function. The inability of
the market to carry out its functions will disrupting market mechanisms,
causing market failures.
While Mrinal-Datta Chaudhuri in Hamid (1999) interprets market failure
as the inability of a market economy to achieve an expected result of the use of
resources. Market failure is only a necessary condition for government
interference. (Malpezzy in Gym, 2004)
According to Rustiadi (2003), the phenomenon of market failure can grow
as a result of the system an economy that cannot provide the necessary
products or consequencesresource allocation failures. Market failures will
occur when various negative externalities fail to be reflected in market prices,

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 or as a result of practices monopolies-oligopoly, or also due to government
failures. Theoretically, market failures will always arise when perfect
competition does not occur. Failure the market can cause a setback (negatively
affect) for all economic actors.
Furthermore, the function of the market according to Miller and Meiners
in Widodo (2013), said that the market has two very important functions,
namely:
1. Competitive markets provide information or knowledge that must be
possessed by consumers and producers in order to take into account
the increase in decline scarce goods or productive resources through
adjustments to relative prices which is easy to understand.
2. The market serves to motivate consumers and producers to react or
give responses in an informed manner. By giving higher rewards is
good it is in the form of wages, profits, or utilities to producers and
consumers, and also better producers the reaction.

Market can be expressed to be a failure or market failure when various

negative externalities fail to be reflected in market prices, or as a result of the
presence of the practice of monopoly-oligopoly, or also due to the failures of
governments. In theoretically, market failures will always arise when perfect
competition does not occur (Rustiadi, 2003).

Thus, the increasing role of government in the economy cannot be

separated from market failure. It is this market failure that which was originally
the background to the need for government interference. Market mechanisms
through invisible hands are considered incapable efficiently and effectivelyin
carrying out its functions in order of Weimer and Vinibg (1992) are is a failure of
the traditional market (Sasana, 2004).

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B. Definition Government Intervention
In general, the government carries out two main functions, namely general
government, namely the regulatory function, regulating political life, social,
order, defense, security including population. In this function it is a
government monopoly in the sense that the other party has no authority to
perform this task. Secondly, the function provision of community services in a
broad sense, such as health, education, postal, telecommunications, etc. This
function does not constitute a government monopoly, but rather is open is also
an opportunity for the private sector to do so. (Sarundajang in Andini, 2013)

With the occurrence of market failures in economic mechanisms, the role

and interference the hands of the government are important to deal with the
problems that occur. According to Barton in Prasetya (2012), the main role of
the government in general is:

1. In resource allocation roles

In the role of resource allocation is covered the question of absolute
sizing and relative government in the economy (balance of public
sector and sector private) and the provision of public goods and social
welfare services for the community.
2. The role of regulators
This includes the laws and regulations that the community needs
including laws governing the business world adequate to facilitating
business activities and private property rights.

The government has an important role to play in the economy, according

to Samuelson and Nordhaus in Sulistiyana et al (2015), explained about the three
functions of government in a market economy, namely:

1. Increase efficiency by creating competition, controlling externalities

such as pollution and providing public goods,
2. Advancing fairness by using taxes and its spending programs to
redistribute government revenues to special groups

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 3. Helping macroeconomic stability and growth such as reducing
unemployment and inflation and boosting economic growth through
fiscal policy and monetary regulation.

CHAPTER III

RESULT AND DISCUSSION

A. Market Failure
Market failure occurs when market mechanisms are not able to optimally
allocate economic resources to individuals. Under these conditions, the market
cannot afford meet the criteria in a market of perfect competition. Criteria in
the perfect competition market, among others, the knowledge of producers and
consumers about the state of the market of perfect competition, the goods
traded are homogeneous, producers and consumers have little effect on the
mechanism of price formation that is more determined by the market
(producers and consumers act as recipients of prices), the absence of artificial
barriers (the freedom to open and close enterprises), and the presence of perfect
mobility of economic resources. If the market fails to fulfil the criteria in a
perfectly competitive market, then the level of production, consumption and
distribution will not reach the optimal pareto. The causes of market failure
include:
1. Imperfect Market Competition
Imperfect competition is the cause of market failure. Under the
market imperfect competition companies experience a decrease in the
slope of the curve demand for its products. Deviation of marginal
income from incomeaverages and prices are no longer the same as
marginal costs. On this condition, the company monopoly sets prices
that exceed marginal costs to maximize advantage. Thus causing an

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 output smaller than that produced by perfectly competing companies
and operating under the same cost conditions. That way, the output
level is at a non-optimal condition. Examples from Imperfect
competition is as follows :
 Monopoly
A monopoly is a market structure in which there is only one seller
or one manufacturer so that there is no competition. On the
monopoly market, manufacturers have the principle of maximum
profit, namely at the production level MC=MR. (MR = marginal
revenue, MC = marginal cost).
 Oligopoly
A state where in the market the number of companies that
dominate the market more than two but not many (2-10), so the
intercompany action will interrelated and influential. The result of
the freedom of each company indetermining policy, especially the
policy of price and production, giving rise to war price and impact
on the crash for some specific companies.
 Natural Monopoly
When the government seeks to abolish a monopoly on an industry,
it will but competition among existing manufacturers will cause
there to be only one manufacturers who are able to survive. This
can be caused because the market for these goods is too small and
the investment required is very large so that the level of an efficient
economy will be achieved when the level of production is large.
2. Public Good
Public goods are goods that when consumed by one of the
consumers do not will reduce the amount available for other
consumers to consume, and its usefulness is in the public interest, there
is no consumer exemption for consumption. That way, public goods
should be provided in large quantities and of the same quality to all
individuals. This situation eventually tends to result in reduced

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 incentives or stimuli to contribute to the provision and management of
public goods. Even if there is a contribution, then the donation was not
large enough to finance the provision of public goods that efficient,
because society tends to give a lower value than should. (Mansjur,
2005)
The use of public goods by one person will not reduce the
usefulness of the goods such in other people as long as the goods are
available, thus causing it not to the presence of competition in
consumption. This condition implies that the market will not be able to
provide goods or services efficiently, since the market functions with
exclude people who do not pay for goods. Therefore, for overcoming
the market failure that occurred, it is necessary to provide a budget for
public goods by the government because the private sector does not
want to provide public goods, while the needs of the community must
still be met.
3. Externalities
Externalities are the impacts borne by economic actors on activities
the economy that is carried out. Meanwhile, according to
Reksohadiprojo (2001), externality is the cost or benefit of market
transactions which are reflected in prices. On economic activity and
action, the efficiency of resource allocation and distribution
consumption on a market economy with free and perfect competition
can be disrupted, if individual economic actors, both producers and
consumers, have externalities both towards themselves and towards
others. According to Pearee and Nash (1991) in Mansjur (2005), the
externalities of the four economic interactions among others:
 Effect or impact of one manufacturer on another manufacturer
A production activity is said to have an external impact on
producers otherwise if its activities result in a change or shift in the
function of production in other manufacturers. An example is in a
production process fabric manufacturing (garment) produces toxic

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 waste products that enter the streams or reservoirs that flow into
the rice fields so that they pollute the plants and harm farmers. In
this case, garment production activities have a negative impact on
other producers (farmers).
 The effect or impact of production activities on consumers
A production activity is said to have an external impact on
consumer if his production activities result in a shift in utility
functions user. An example is the reduction of green open land
with air that fresh because of the construction of the factory. In
addition, often the production activities of the plant produce waste
that pollutes the water, thereby disturbing the wider community
(consumer).
 The effect or impact of one consumer on other consumers
The impact of consumers on other consumers occurs if one's
activity or certain groups affect or interfere with the utility
functions of other consumers.The impact of one consumer's
activities on other consumers may occur in various forms. Like,
someone's cigarette smoke in a public place.
 The effect or impact of a consumer on producers
The impact of consumers on producers occurs if consumer activity
interferes the production process of a particular manufacturer or
group of manufacturers. For examples disposal of household waste
in rivers that pollute river water thus interfering with producers
who utilize clean water, for example, farmers.
4. Institutional Failure
Gillis, Perkins and Roemer within Nizar, have identified
institutional failure as a major cause of market failure in emerging
markets. It is based on the view that underdeveloped institutions
exclude many people from the market. Institutional failure causes
damage in developing countries. Despite the government has rights to
most forest areas in developing countries, but the government is unable

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 to enforce regulations in this area. Forests are publicly owned
resources but the cause of forest destruction is the institution itself,
while market mechanisms cannot regulate the use of resources public
property. This market failure is known as the "tragedy of common".
5. Transaction Cost
A market is said to be complete if it produces all goods and
services whose production costs are less than the price that the people
are willing to pay. There are several types of services that are not
cultivated by private parties in sufficient quantities even though the
cost of providing these services is smaller than what the community is
willing to pay. Such conditions are referred to as markets that are not
complete. There are several reasons that result in an incomplete market
namely, the existence of innovation, transaction costs as well as
information asymmetry and execution costs. (Stiglitz, 2000)
Transaction costs are translated as costs incurred as part of a
production cost of the total cost of production (total cost). Various
rules, levies wild, rent seekers and free riders cause high transaction
cost.
Transaction cost are not only in financial form, but also influenced
by uncertainty in planning. Business uncertainty for entrepreneurs
means relating to risks that have high risk consequences, so that effect
on the desired profit margin.
The problem of transaction costs can be solved by shortening
bureaucratic lines, increasing legal certainty, eliminating free riders
and rent seekers, and creating an effective statutory and institutional
system in preventing the occurrence of transaction cost.

Of the several causes above, of course, market failure can result in losses
and inefficiency in several ways, namely:

1. Regional/state development can be hampered

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 Market failure can lead to the instability of the people, and it
certainly affects the development of the country. If its people are not
prosperous, the possibility for the payment of taxes will be low, and
the country will have a hard time getting income for development
financing.
2. The existence of a high income gap
Owners of companies capable of dredging up high profits can it is
certain to be rich, while the laborers they have will still in poverty
without being able to do anything about it. This makes the rich party
becomes richer and the lacking party will remain shortages if the
government does not take immediate action.
3. Uneven distribution of income in remote parts of the country
Indonesia's geographical conditions that are not the same as each other
make the market in Aceh certainly different from the market in Papua.
It may be that, with limited transportation in Papua, the income
generated is lower than aceh, and vice versa.

B. Government Intervention
The existence of market failure is one of the reasons why the government
should intervene in the economy so that the welfare of the people can be
achieved in a optimal. The purpose is as follows:

1. Guaranteeing equal rights of each individual and eliminating

oppression
2. Maintain the economy so that it can grow and experience development
stable
3. Supervise the activities of companies, especially companies that
control the market in order to not engage in harmful practices
4. Provide public goods such as highways, schools and security for
improving the welfare of society
5. Reduce the externality of adverse economic activities

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 Meanwhile, the role of the government in the economy can be categorized
into three groups, including:

1. The role of allocation

The government plays a role in providing the economic tools that
people need, which cannot be produced by the private sector, such as
in the provision of roads, hospitals, schools and security.
2. The role of distribution
The government plays a role in distributing the country's income
and wealth for the welfare of society. Therefore, the government
makes policy policies so that the allocation of economic resources can
be distributed evenly, including through:
a) Taxation
b) Subsidies
c) Poverty alleviation
d) Educational assistance
e) Health assistance
f) Regional development assistance
3. The role of stabilization
An economy completely handed over to the private sector will be
very vulnerable to shocks that can lead to unemployment and inflation.
Therefore, the government has a major role as a stabilization tool
economics. The role of the government in maintaining economic
stability can be carried out by keeping economic problems from
spreading to other sectors and controlling inflation through policies
made.
For example, on imperfect competition, where the market is
controlled by one or some enterprises, which led to the complete
determination of the price of goods controlled by monopolists. Thus,
the government made several efforts in the form of price control and
the imposition of taxes. By control maximum prices on perfect
competition, monopolies will operate at the same level of price and

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 output so that efficiency of resource allocation occurs, because the
price formed reflects its marginal costs. On the other hand, the
establishment of taxes will affect the output produced by monopolies
and the price, so the price becomes higher and the profit is reduced.
Thus, price control policy is a more effective policy than tax policy to
overcome market failures.
Without government intervention, the economy becomes
uncontrollable which can lead to inflation, unemployment and
inequality that affects economic stability.

In carrying out its role, government interference is not always able to

improve people's welfare. Sometimes government intervention can actually
have an impact on the emergence of a new problem that was not identified
before, in other words, there was a failure of the government. Factors causing
government failure include:

1. The very dynamic state of the field leads to impending conditions very
difficult to identify
2. Often government policies do not match the reaction of the people
3. The existence of parties in government policymakers who aim to
achieve vested interests
4. The existence of obstacles in the bureaucracy
5. Surveillance and inaccurate information

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 CHAPTER IV

CONCLUSION

A. Conclusion
The government has an important role in the process of economic activity,
which is in the form of functions allocation, distribution and stabilization. On
conditions of market failure, requiresthe government to intervene by issuing
various policies or plays a direct role in economic processes. Market failure
itself is a state in which the market mechanism is unable to allocate economic
resources to society, that is, where the market does not meet the criteria of
perfect competition, such as producers and consumers' knowledge of the state
of the market of perfect competition, goods traded are homogeneous, producers
and consumers have little effect on the price formation mechanisms that are
more determined by the market (producers and consumers are not the
recipients of prices), the absence of artificial barriers (freedom to open and
close businesses), and the presence of perfect mobility of economic resources.
If the market is unable to meet these criteria, then the levels of production,
consumption and distribution will not reach pareto optimal.

Factors causing market failure include the presence of imperfect

competition, the presence of public goods, the presence of externalities, the
occurrence of institutional failures and non-optimal transaction costs.
Therefore, the role of government is urgently needed to overcome market
failures that occur. The form of the government's role in overcoming market
thwart that occurs includes the allocation function, distribution function and
stabilization function.

However, government interference is not always able to improve the

welfare of the people, or it is called a failure of the government. The things that
cause the failure of the government include the very dynamic state of the field
causing the upcoming conditions to be very difficult to identify, often

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 government policies are not in accordance with the reaction of the people, the
presence of a party in the maker government policy aimed at achieving self-
interest, the existence of obstacles in the bureaucracy, as well as surveillance
and inaccurate information.

B. Suggestion

The government in carrying out its functions to improve the economy

must strive to the maximum, fairly, transparently and thoroughly. The policies
taken should be in accordance with the current conditions community. The
government should conduct field studies in every policymaking or when
becoming a direct economic actor.The whole society should be able to work
together to create conditions conducive economy. And Governments should create
regulations that can encourage the creation of optimal economic system.

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 BIBLIOGRAPHY

Stiglitz, J. (2000). Economic of The PublicSector. Fourth Edition. W.W.Norton &Company

London

Sasana, H. (2004). Kegagalan Pemerintah Dalam Pembangunan. Jurnal Dinamika

Pembangunan (JDP), 1(Nomor 1), 31-38.

Hamid, E. S. (2016). Peran dan intervensi pemerintah dalam perekonomian. Economic

Journal of Emerging Markets, 4(1), 41-58.

Mangkoesoebroto, Guritno. (2000). Ekonomi publik. Yogyakarta: BPFE.

Mansjur, Eka Denny. (2005). Alternatif Kebijakan Ekonomi Publik Melalui Role of
Goverment terhadap Terjadinya Kegagalan Pasar. Jurnal Ekonomi dan Bisnis,
2(3).

Nizar, Muhammad. Kegagalan Pasar, Accessed October 20, 202 , from

https://id.scribd.com/doc/193578252/Kegagalan-Pasar-Muhammad-Nizar