Market Imperfection Failure

In the real world perfect competition is very rare and the model is more theoretical than practical , because of the imperfections that exist in the market mechanism. There are five broad types of phenomenon that lead to inefficient market outcomes: monopoly power, externalities, income inequality, factor immobility and nature of market. Therefore this warrant for government intervention for the removal of those imperfections for the society welfare. The economist Milton Friedman argue that removal of market imperfection does not imply that government is successful because usually the cost of government failure might be worse than the present situation of the market imperfection it attempts to fix. This failure is seen as a result of

1) Externalities

Critics of market imperfection sometimes invoke externalities. A classic example of negative externality is a steel firm that cause air pollution affecting the health and clean up costs on the whole society. Since these costs are not considered , it results in market inefficiencies, unless proper action is take. Therefore the firm produces to the point where its private marginal cost equals the market price, at point Q2 shown in figure 2.

As such government introduces policies like pollution tax, landfill tax, climate change levy etc . For instance by internalizing the firm the externality, i.e making the firm bearing the social cost of production will eventually lead the firm to produce at the optimal output at Q1. However in practice an optimal level of pollution is difficult to determine because accurate estimates are often difficult to obtain specially when technology of pollution is changing and the various new pollutants are unknown . The techniques available for regulating pollution are imperfect in themselves. Even the optimal level of pollution control is known, there are both legal and technical impediments to achieve that level through

For instance the problem of information failure leads to underproduction of merit goods and over production of demerit goods. These issues can be resolved through market, legal and regulatory remedies. For instance, once information is known to people this makes it difficult to charge users enough to cover the costs of production and causes the private firms to produce too little.

4) Income Inequality

The widening gap between rich and poor people leads to inequitable market distribution of goods and services. Moreover resources are more diverted to high income consumers leading to misallocation of resources. Policies for an equitable distribution by government usually conflict with the goals of more efficient economy as it is likely to inhibit the efficient operation of price system. Equitable income distribution is also likely to discourage people to work at their best capabilities leading to