Unit 1
Unit 2
The Australian Economic System
Market Failure
It is easy to assume from the preceding pages that market economies can answer all of our questions, and the best thing that we can do is just leave the economy to operate without government intervention. This is certainly partly true, but there are also many times when the Australian economic market will fail. These circumstances need to be identified so that we know when the government should act to ensure that economic activity will be able to be sustained in the future.
1. Market Power: In a purely competitive market it is possible that one firm (or a small group of firms) could end up dominating. As you can see from the work that you have already done, the market system relies on the fact that sellers respond to the actions of consumers (consumer sovereignty). In this case, we would say that the sellers become price-takers rather than price-setters. For example, very few countries around the world are able to produce crude oil for export. Many of those that are able to mine oil have grouped together to form the Organisation of Petroleum Exporting Countries (OPEC). This group is able to manipulate the price of oil by changing the level of output each day. Reducing output will act to increase prices. In Australia the government acts to ensure that firms are not able to gain market power. You will explore the specific actions used to make this possible later in the course.
2. Public Goods: There are some things that won’t be provided by the free market at all. This is because the free market is driven by the profit motive; if I can make a profit then I will operate in that market, but if I can’t make a profit then I won’t. For example, there is no way to make a profit by providing street lights. This is because we can’t exclude people who do not pay. It is also true that when one person uses a street light, it doesn’t prevent others from doing the same thing. Compare this with a loaf of bread; if I have a loaf of bread, you can only take it from me if you pay me for it. After you have eaten it, the bread can’t be used by someone else. As a result, it has economic value. The government does not provide bread, because others can operate in this market and make a profit from it. But the government does supply the police force, most roads, the fire brigade, street lights, public parks and libraries, and if they didn’t provide these things then it is likely that we wouldn’t have them at all.
3. Externalities: An externality is a side effect of production or consumption. In other words, it is an unintended consequence of our economic actions. For example, when you choose to drive in a car it will produce pollution. Externalities can be negative, but they can also be positive. For example, if I choose to visit the doctor to ensure that I am immunised against the ‘flu virus, then it is less likely that I will contract this illness. Now that I have been inoculated, when I speak to other people it is also less likely that they will get sick. In this way they have received a benefit, even though they weren’t a party to the original transaction.
Both positive and negative externalities are examples of market failure. In the case of negative externalities, we can see that the market has failed because the product is being over-produced or over-consumed. On the other hand, with a positive externality our problem is that we aren’t making or consuming enough of the product. Either way, we are not allocating our resources efficiently, and this is why they are both market failures.
4. Asymmetric Information: Another assumption of the market mechanism is that buyers and sellers both have perfect access to information, but the truth is that this is rarely likely to be true. A clear example of this is when you choose to purchase health insurance. While your insurer can ask you to have a medical check, it is possible that you will have a medical condition that you know about, but the same information is not available to your insurer. In this case the insurance will be worth more to you than the insurer realises, and they might end up providing too many policies to the market. On the other hand, it is also possible for producers to have access to information that is not provided to consumers. When a wholesaler buys fresh produce, they normally buy it in a large crate. It is possible for a seller to put all of the best produce on top, which will create the impression that the products are better than they really are. This might cause the wholesaler to buy too many of these items. In either case, the market will not be operating efficiently.
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