Should we correct market failures or adapt to them?

Should we correct market failures or adapt to them?

22nd August 2015 Ideas, Uncategorized 0
By Ben Clarke, Cranleigh School

It is my personal opinion that the whole idea of a market failure is to identify the areas of our society which are not working to their full potential (i.e. the goods and services that have a market failure are not being economically efficient – and therefore are not benefitting to society). For the purposes of this essay, we shall use the traditional definition for a market failure: being any point where the market fails to achieve economic efficiency. We would say that this is any good or service where production takes place not using the least amount of scarce resources (productive inefficiency), or not achieving a point at which consumer satisfaction is maximised (allocative inefficiency). Therefore, if goods and services are failing in the market, it means that either they are using too little or too many scarce resources than needed, and that the consumers are not getting the correct amount in order to satisfy themselves. For me, the whole idea of a market failure is to make society run in a smoother direction, making sure that everybody has consumed the correct amount in order to benefit society as a whole. And so therefore, they should be corrected, instead of adapted.

By simply adapting to the market failures, we are no longer trying to vie to have a better life; to make society as a whole a better place to live. In essence, by adapting to the market failures, you are denying the fact that the market is failing, and simply just ignoring the fact that that good or service is taking vital scarce resources away from the production of another good or service, which could potentially better society. If we are taking a very utilitarian point of view, the idea of market failures, is to adjust the market so far as to promote happiness, and that the greatest happiness for the greatest number should be the principle of conduct in society. By simply adapting to market failures, we are no longer satisfying the many but satisfying the few. This is because the market fails due to certain individuals, or group of individuals, utilising the free market mechanism in order to make the most of themselves, rather than the most of society, and by adapting to market failures, we almost would fuel this, leading to even worse and worse situations. We can only remedy this, by correcting the market failures as close to perfect as we can.

There are several different types of market failure – demerit goods; merit goods; negative and positive externalities; and public goods to name but a few. All of them are designed to help us see where the market is slipping up, in order to correct it, so that they best amount of scarce resources are used for the production of that good, and so that the correct amount of scarce resources are used so that all the consumers are happy – so that allocative efficiency is maximised. At the moment, we live in a society where there are several significant market failures. I believe that it is governments job in order to help correct these so that society, as a whole, benefits from the specific amount that is needed for society to function in the most efficient way possible.

To take a more practical approach to the idea take, for example, the tobacco industry. This is an industry with a significant market failure. Not only is it a demerit good, due to the fact that the actual health risks are unknown fully, and we cannot quantify the harm that it will bring (for example, we know that cigarettes cause cancer, but we are not aware of how long each cigarette will take off of the smoker’s life; but as well as the fact that there are significant negative externalities as well, for example second hand smoke affect the third parties of passers-by on the street, or that the cigarette butts create mess and litter which is effecting the third parties who use the street. The government has taken significant action in order to combat this market failure. Not only is there a large tax on tobacco products, but there is regulation, in terms of legislation against people under the age of 18 purchasing the product. Moreover, there is more to come, the current government are thinking about introducing legislation which would remove packaging from cigarettes – as has been introduced in Australia in 2012 (Source: Australian Government Department of Health) – all in an attempt to reduce the quality consumed of cigarettes.

All these things have been done in order to fully benefit society in the best way possible. By bringing in all of this legislation, you essentially are trying to limit the amount of scarce resources that are used to produce these goods and services, and so reduce both the negative externalities and the demerit good aspects of tobacco. This, in turn, will help the market to come closer to correcting, and so benefit society in the best way possible – by using the appropriate amount of scarce resources, and by making sure the correct amount of people get the correct amount of the good or service.

However, there is a problem with correcting the market failure, in the fact that it has an inherent flaw, by the fact that it is uncorrectable. But where is the productively efficient point? How do we know when we have used the precise amount of scarce resources? And this is the fatal flaw. By nature, a market’s price and quantity is dictated by the laws of supply and demand, which itself is led by the invisible hand. If demand for one product goes up, then the price of the good goes up, and the quantity demanded goes up; if the supply of service increases, then the price decreases, and the quantity demanded increases. However, this is a constantly changing process, with these two motions constantly shifting and changing the quantity and price, which therefore means that it is impossible to tell when the perfect amount of goods have been sold using the precise amount of scarce resources. This number is impossible to quantify, and therefore is impossible to reach, and herein lies the problem; that it is pointless chasing these market fails, because they are impossible to correct.

What is more, there is another fatal flaw to do with this, in the fact that, as Adam Smith says, people (and business) are self interested. Take for example again, the tobacco industry. We are all well aware of the problems of smoking due to the work of scientific research, not only is it a demerit good (in the fact that we cannot quantify how bad cigarettes are for us, and therefore consume to much), but also by the fact they are negative externalities, the prevalence of second hand smoke, for example, affects third parties in a negative way. Therefore the tobacco industry represents a huge market failure, but although measures are being made to reduce it, for example by raising taxes, it is never going to work. This is because business are not going to stop production when the productive point is being reached, because they are interested in the point where they are going to maximise profits. The same goes for people. They are likely not going to stop having that extra cigarette because of the effects of second hand smoking on passers-by, and so despite these measures, the market failure will never be solved. This begs the question; is it not simpler just to adjust to this market failure, rather than fruitlessly tire over something that cannot be fully fixed?

It therefore could be agreed with, therefore, that trying to correct something that it uncorrectable is a doomed task with an inherent flaw. But I would strongly disagree with this. This is a very cynical view of life. The idea of a market failure is not to ‘correct’ the market as per say, but adjust it to the nearest possible point, in order to make sure that society receives the maximum benefit of the good or service, without the over or under indulgence of said good.

About the author

Andrew Tan: Head of Technology and Website Development. 2nd year Economist at St. John's College. Please e-mail me with any inquiries/issues regarding the website at itofficer@marshallsociety.com!

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