market failure

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Within markets function analysis, many authors considered that "the existence of "market failure" and/or "government failure" has fuelled a lively debate about the relative merits of using the market or the state to coordinate and undertake various kinds of economic activity".

Discuss the above statement using examples.

Market failure takes place when the forces of the market are allowed free play but several inefficiencies develop. On the other hand government failure happens when the government intervenes in the market but is not able to achieve its objectives.

Adam Smith had described the invisible hand a scenario where individual's pursuit of self-interest in the market leads to results that are efficient. However, it has been observed that production or uses of goods and services by the market is not efficient. This situation becomes very noticeable where the availability of necessities is adversely affected. When the production and sales of goods and services is not efficient without intervention it is termed as market failure. Where there is market failure, there is a demand for government intervention. The demand is that the government should intervene and correct market failure. For instance, if the prices of food products increase very rapidly causing a shortage, there is a demand that the government should place ceilings on the prices. There are several means that the government may use to counter market failure. These include regulations, price controls, wage controls, taxes or even subsidies. For example, the government may subsidize the prices of fertilizers used in wheat cultivation and may impose a price at which the wheat may be sold/bought.

From another perspective if the markets are not working in a favorable manner the situation is taken as a pretext by the government to intervene in the market. One of the classical examples where the government intervenes is in the production and distribution of public goods. The government provides services like, police, parks for the public and military defense. Another, pretext for intervention is that there is too much of inequality between the poor and the rich. To reduce this different the government intervenes in the market. For instance, it may increase the minimum wages that need to be paid or it may increase taxes on the higher income slabs. Another reason that the government uses to intervene is the existence of monopoly power in the market. Some feel that monopoly power is one of the sources of market failure and so the government intervenes either to break up the monopoly or to set up laws that disallow the exercise of monopoly power. The government also intervenes in case of ...