Market failure is caused by the market failing to provide the type or quantity of goods and services wanted by consumers. This means that resources have not been allocated efficiently. This could be because of four factors: imperfect competition, external costs and external benefits are ignored (externalities), public goods are not provided, or merit goods are not provided in sufficient quantity.
Imperfect competition
From a business’s point of view competition is bad as it drives down the price of the product they are trying to sell but for the economy as a whole it is a positive thing as many customers are having their wants and needs met.
Imperfect competition can cause market failure through monopoly, a monopoly is a singular supplier of a product which can lead to exorbitant pricing or inferior products as consumers have no other options. Another cause of imperfect competition is an oligopoly which is very few dominant suppliers providing a product giving one supplier the opportunity to drive up the price allowing the other suppliers the freedom to do the same. An oligopoly also increases frequency of cartels. A cartel is a mutual agreement between suppliers and possibly producers to keep prices at a set price leaving consumers with no option to shop around for a better price.
Externalities
An externality is something that is a by-product or consumption which affects a third party externally. Externalities can be positive or negative. Positive externalities have a positive effect on persons through production or consumption of the product. Some examples of these benefits could be education which not only benefits the student but also society gains an educated workforce. Another beneficial externality would be inoculations of children meaning that they do not miss school due to illness and more importantly do not suffer long term damage or disability as a result of serious illnesses which they have been immunised against.
Negative effects are also created through the production or consumption of a product. Some examples of negative externalities are: noise pollution which could be caused by wind farms, being below an airplane flight path or living in close proximity to a pub or nightclub. Other negative externalities could include blights on the landscape such as quarries, nuclear power plants, wind farms, chemical treatment plants, steel works or landfills.
Provisions of public goods
If public goods were left to the market it is unlikely that the market would provide such goods as they cannot be protected from, free riders (free riders are people who use the services without paying). The government provides public goods for the best of society. Street lights, light houses, national defence, the police service, public drainage, environmental goods, information goods, food control, software development and museums are some examples of these. Merit goods
Merit goods are products which consumers may under value but which the government believes are beneficial for consumers and in turn society as they provide positive externalities.
As merit goods only hold worth as positive externalities they would be under-provided within the market. To deal with this issue they are part or wholly provided by the government.
Merit goods include healthcare (without this we would all need health insurance and like America some low income families would be unable to afford this) inoculations for children & teens, fire service, rubbish collection, education, work training programmes, libraries and the citizens advice bureaux.
2a.
Government’s defence against imperfect restricted competition regulation is used and is the responsibly of the Office of Fair Trading. The Office of Fair Trading enforce relevant regulations known as competition policy.
Restricted competition is not always considered a bad thing. A firm maybe considered a monopoly, yet produce a medical treatment which can save the lives of millions of people. However should the firm abuse its monopoly position by charging extortionate prices it can be deemed to be against the public interest and subject to legal sanction.
2b.
The Office of Fair Trading rely heavily on the UK competition law which comprises of five principal Acts of Parliament, which are: Fair Trading Act 1973, Restrictive Trade Practices Act 1976, Resale Prices Act 1976, Competition Act 1980, Competition Act 1988 and Enterprise Act 2002.
Monopolies can be a scale monopoly or a complex monopoly. Monopolies can occur for many reasons but the most common are natural monopoly, size (where an industry requires such a large scale investment), contrived (monopoly has occurred due to a merger). The definition of a merger is covered by the Fair Trading Act 1978.
Restricted Practices are where groups of independently controlled firms actively collaborate in operating agreements to restrict completion within an industry.
Firms can achieve this through a variety of practices such as elevated minimum pricing (RPM), predatory pricing and the tie in of non-related goods and services.
Under the Restrictive Trade Practices Act 1976 and Resale Act 1976 many of the afore-mentioned agreements are illegal and only those which can be proven to be in public interest are allowed. Restrictive agreements have to be registered with the Office of Fair Trading and are illegal unless the firms involved can establish grounds for exemption before the Restrictive Practices Court. The overall responsibility for competition policy is in the hands of the Secretary State for Trade and Industry. The Director General of Fair Trading oversee the market place and the Competition Commission have the job of investigating monopolies and proposed mergers.
2c.
When a firm has been proven to be acting against public interest the government can take them over (running them in public interest) or regulate them through legislation. Punishment towards firms that commit restrictive practices is limited and the most common recourse used by government is a request to the firm to voluntarily rectify their practices to be in line with legislation.
Since the passing of the Competition Act 2008 the Government is now able to fine a firm up 10% of their turnover under the premise of anti-competition behaviour.
The system utilised can be flawed as those in the Competition Commission investigation constantly change leaving the report recommendations inconsistent. Case-by-case review is a slow process averaging 2-3 years of processing time and after recommendations the Government often ask firms to voluntarily rectify the noted issues.
Not all qualifying firms are referred. Questions have been raised as the success of the system but it has seen some success.
After opening up the monopoly situation of British Telecom the Government intervened by creating OFTEL a body whose responsibility is to regulate the monopoly. Other Government bodies whose purpose it is to regulate monopolies are OFGEM – responsible for gas and electricity, OFCOM – Completion authority for the UK Communications industries, etc.