Market failure may be caused by An externality, which is the impact of one person or firm’s actions on the well-being of a bystander. The typical example of an external cost is pollution. Market power, which is the ability of a single person or firm to unduly influence market prices. For instance, if everyone in the town needs water, but there is only well.
One goal of the study of economics is to help you judge when a government policy is justifiable to promote efficiency or equity, and when it is not.
▪ C. How the economy as a whole works ▪ Principle #8: A country’s standard of living depends on
• Because households and firms look at prices when
deciding what to buy and sell, they unknowingly take into account the social costs of their actions. • As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as
China’s case: gradual economic reform in property rights
▪ 2. Another reason why we need government is that although markets are usually a good way to organize economic activities, this rule has
its ability to produce goods and services
1. Changes in living standards over time are also large. In
the US, incomes have historically grown about 2% per year, but average income doubles every 36 years while China has grown in recent 30 years about 9%, but average income doubles for 15 years. • Almost all variations in living standards are explained by differences in countries’ productivities. • Productivity is the amount of goods and services produced from each hour of a worker’s time. The growth rate of a nation’s productivity determines the growth rate of average income.
Principle #7: Governments can sometimes improve market outcomes. 1. If the invisible hand of the market is so great, why do we need government? This is because the invisible hand needs government to protect it. Market works only if property rights are enforced. In modern economy, all the households and firms rely on government-provided police and courts to enforce the rights over the things firms produce.
▪ There are two reasons for a government to intervene in the market:
▪ (a) to promote efficiency. The related policies aim at enlarging the pie
▪ (b) to promote equality. The related policies aim at changing how the pie is divided.
2.Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand” that led them to desired market outcomes for prices are the instrument with which the “invisible hand” directs economic activities.
In these two cases, well-designed public policy is believed to enhance economic efficiency
4. The invisible hand may also fail to ensure that economic prosperity is distributed equitably. A market economy rewards people according to their ability to produce things that other people are willing to pay for. A world’s best basketball player earns more than the world’s best chess player simply because people are willing to pay more to watch basketball than chess. The invisible hand does not ensure everyone to earn as more as he/she can. Many public policies aim to achieve a more equitable distribution of economic well-being.
5. But, government does not always improve market outcomes at times.
Public policy is made not by angles but by a political process that is far from perfect. Sometimes, policies are designed simply to reward the politically powerful. Sometimes, they are made by well-intentioned leaders who are not informed.
3.Although the invisible hand usually leads market to allocate resources efficiently, that is not always the case. Economists use the term market failure to refer to the situation in which the market on its own fails to produce an efficient allocation of resources.
a whole.
3. When the government prevents prices from adjusting naturally to supply and demand, it impedes the invisible hand’s ability to coordinate the millions of households and firms that make up the economy. For example, taxes distort prices and thus the decisions of households and firms. It also explains the even greater harm caused by policies that directly control prices, such as rent control. It is worthy of note that only under the circumstances of complete market and perfect market is there no need for government to intervene.