Refers to the failure of the market to allocate resources efficiently
When allocative efficiency is not achieved resulting in under or overallocation of resources (not socially optimal)
Allocative inefficiency
Market failure results in allocative inefficiency, where too much (overallocation of resources); or too little (underallocation of resources) of goods or services are produced and consumed from the point of view of what is socially most desirable.
i.e. Resources not allocated efficiently, equilibrium is not achieved & there is dead weight loss ==> market failure & allocative inefficiency
Allocative efficiency is achieved when D=S or when MB = MC
Marginal Benefit: MB
Benefits received by consumers for consuming one more unit of the good
Marginal Cost: MC
Cost to producers of producing one more unit of the good
Competitive Market:
Competitionfor market share
Allocative efficiency is achieved
Total surplus is maximised
Homogenous products
Large number of buyers and sellers
No market power: Price takers
No barriers to enter or exit market
Imperfect Market:
Some to No Competition for market share
Allocativeinefficiency is achieved
DWL is present
Differentiate products, but are still close substitutes
Small number of buyers and sellers
Market Power: Price setters
Barriers to enter or exit market
Perfect Competition
Homogenous products - sells similar products at similar prices, therefore lots of competition
Large number of buyers and sellers
No market power, firms can't set price, take price that is set by market
Price takers, allocative efficiency is achieved
No barriers to enter or exit market
E.g. Agricultural market
Monopoly
One firm
No close substitutes for product
Firms are price setters, have to pay the price if they want the product as they can't go anywhere else
High barriers to entry
E.g. Utilities (water, energy)
No substitutes
Hard to set up, equipment
Usually controlled by government to prevent
Oligopoly
Few large firms
Goods are close substitutes
Barriers to entry exit
Sellers are interdependent - engage in strategic behaviour
All raise prices together, price setters
E.g. Supermarkets (coles, woolies, IGA, Aldi)
Similar products and price ranges
Monopolistic competition
Similar to competitive markets but different in the sense that there are product differentiation: physical, quality and location
Many firms
Differentiate products, but are still close substitutes
Lower barriers to entry
Information is imperfect - sellers know more about product, consumers don't know true value/cost
Firms are price setters
E.g. Phone industry, computers
Barriers to Entry:
Economies of scale: permitting lower average costs to be achieved as the firm increases its size
Average total costs of a large firm are substantially lower than the average costs faced by a smaller firm
Larger firms can afford machinery to make things in bulk
Large firm can charge a lower price than the smaller firm, and force the smaller firm into a situation where it will not be able to cover its costs
Barriers to Entry:
Branding: creation by a firm of a unique image and name of a product
Advertising campaigns that try to influence consumer tastes in favour of the product, attempting to establish consumer loyalty.
Does not lead to monopolies, methods used by oligopoly and monopolistic competition
E.g. apple products
Barriers to Entry: Legal:
Patents: rights given by the government to a firm that has developed a new product or invention to be its sole producer for a specified period of time
They will have a monopoly during this time e.g. patents on new pharmaceutical products
Does not lead to monopoly buy limit competition
Barriers to Entry: Legal:
Licenses: granted by governments for particular professions or particular industries
E.g. license may be required to operate a radio or television station
Barriers to Entry: Legal:
Copyrights: guarantee that an author has the sole rights to print, publish and sell copyrighted work
Barriers to Entry: Legal:
Public franchises: granted by the government to a firm which is to produce or supply a particular good or service
Barriers to Entry: Legal:
Tariffs, quotas and other trade restrictions: limit the quantities of a good that can be imported into a country, thus reducing competition
Barriers to Entry:
Control of essential resources: monopolies can arise from ownership or control of an essential resource
E.g. DeBeers, the South African diamond firm, that mines roughly 50% of the world’s diamonds and purchases about 80% of diamonds sold on open markets
Barriers to Entry:
Aggressive tactics: when existing firms use tactics to discourage new firms from entering the market
Anti-competitive behaviour: Agreements or arrangements between firms that seek to restrain competition and remove the automatic regulation that competitive markets achieve.
Price Fixing
A practice whereby rival companies come to an illicit agreement not to sell goods or services below a certain price
Market Sharing
A market is divided into a series of smaller markets, each supplied by one of the firms, thus reducing competition
Cartel
When firms agree to act or collude together instead of competing with each other – includes both price fixing and market sharing
Collusion
General term describing agreements between firms – either price or market sharing – to reduce competition and increase profits
Collusive Tendering
Firms agree to submit exorbitant tenders which ensure high profits and the sharing of work between the collusive members
Predatory pricing
When a company with substantial market power sets is prices at a sufficiently low level with the purpose of eliminating or substantially damaging a competitor
Resale price maintenance
The supplier sets the price at which a retailer must sell its products. The manufacturer may refuse to sell to any retailer which may resell their products at a discount
Exclusive dealing
When one person trading with another imposes some restrictions on the other's freedom to choose which whom or where they deal
Collective boycott
When a group of competitors agree not to acquire goods or services from, or not to supply goods or services to, a business with whom the group is negotiating
Merger
Two or more firms jointogether to form one larger firm – prohibited if it substantially reduces competition in the market
A firm has market power if it is able to affect the market price by varying output
The lower the number of firms, the more market power the remaining firms have
Policy Options to Correct Market Failure:
Regulation
If there is a natural monopoly, it is not in society’s interest to break it up into smaller firms, as this would result in higher average costs and would be inefficient.
Governments usually regulate natural monopolies, to ensure more socially desirable price and quantity outcomes
Governments also control who enters the market
Goal is to benefit the most of society
Policy Options to Correct Market Failure:
Deregulation
Too much regulation, firms can't be innovative, improve
Government regulations that restrict competition include:
Limiting the number or types of businesses
Limiting the ability of businesses to compete
Reduce the incentives for businesses to compete
Limiting the choice and information available to consumers
Some government regulations need to be de-regulated to enhance competition
Policy Options to Correct Market Failure:
Legislation
Legislation: put in place to limit anti-competitive behaviours to achieve a greater degree of allocative efficiency
Example: ACCC: aims to protect, strengthen and supplement the way competition works in Australian markets and industries
They enforce the competition and consumer act 2010 and other legislation promoting competition and fair trading.
Purpose of the ACCC: Promote competition and fairtrading
Market power will normally result in Increased producer surplus and decreased total surplus
Market failure occurs when the market fails to allocate resources efficiently, meaning allocative efficiency is not achieved, resulting in under or overallocation of resources, which is not socially optimal