Externalities are based on the impact of an individual action on the well-being of a bystander. Hence, they enforced people other than the consumers and producers of goods and services. Thus, externalities are also described as spillover effects. Third parties are refer as people except consumers and producers who are affected by these side-effects of market exchanges. Externalities may be either positive or negative which it may cause beneficial or disadvantageous to the third party. For instance, we are off to bed and our neighbour is having a dancing party with high volume rock music. The action of our neighbour is imposing negative externality toward us and the third parties who are trying to sleep. As the results from annoyance of our neighbour’s playing the music, this is an example of a consumption externality.
However, externalities are also an external positive externality too; by the way, negative externalities are only caused by market failure. On the other hand, the production externality is generated, for examples, depletion of natural resources are caused by atmospheric pollution from factories and the long-term environmental damage. The factories expel harmful gases such as CFC, carbon monoxides, hydrocarbons from the chimney that causes bystander health. The externality is considered to be an important factor contributing to economic growth.
Market power is also one of the reasons of causing market failure. Market power, which refers to a firm, can influence the price by exercising control over its demand, and supply. It does not exist when there is a perfect competition, but it does when there is monopoly, cartels, or monopolistic competition. The invisible hand of the market leads to an allocation of resources that makes total surplus larger as it can be. As monopolies can lead to an allocation of resources unlike from a competitive market, the monopolists keep its prices and profits high by using its market power to restrict output below the socially efficient quantity. The monopolists choose the profit-maximizing quantity of output at the intersection of the marginal-cost curve and the marginal-revenue curve. It is not at the lowest point of the average total cost curve, intend that the available resources are not fully use and it will fail to produce an efficient allocation of resources. The inefficiency of monopoly also can be measured with a deadweight loss triangle area between the marginal-cost curve and the demand curve, which reflects the total surplus loss and the costs of the monopoly producer. Buyers who have willingness to pay less than the price will not buy it. It is the reduction in economic well-being that fall out from the monopoly’s use of its market power. Microsoft market shares in PC operating system in the natural monopoly are one of an example because everyone is using their products. It would also leads to an increase in competition and variety as well as cheaper products for consumers. Moreover, after determining the level of Microsoft’s market power, we know that the relevant market is the licensing of all Intel-compatible PC operating systems world-wide. In addition, some consumers may not interest on some types of application, they might seek for others, such as Apple Company.
Other than those reasons above, the reason which will cause market failure happen is public goods. Public goods can define as goods that will not reduce the availability of it for consumption by others after people making consumption. By the way, once public goods are available, no one can be withheld to consume them for free. Public goods are usually provided by the government examples like protection provided by police, fire departments, and the military. Public goods may provide free rider problem, which means the private organizations cannot get all the benefits of the public goods which they have produced, there would be no incentive for them to voluntarily provide public goods; consumers can take advantage of public goods without contributing sufficiently to their creation. This situation can produce inefficiency and a resulting market failure.
When markets failure occurs, it will eventually affect economic recession, social unemployment rate to increase, financial deficits, and inflation and so on. In order to seek full employment, price stability, maintain economic growth and international revenue as well as expenditure in balance; government will launch a series of economic policies to intervene the market economy and to correct market failures. Government policy is a kind of coercive force which is a noticeable act that controlled by individuals and organizations’ performance during the trade. Moreover, the government policies are divided into three parts, which consist of taxes, price control and subsidies.
Tax is an imposed manner which the burden of a tax is shared among participants in the market. When a tax is imposed on goods, this will affect supply curve to shift upward by the amount of the tax. In addition, taxes can directly and indirectly affect on other area such as cigarettes, petrol, and alcoholic drinks.
According to the text above it has already shows out that an increase in tobacco tax is the best means to reduce tobacco uses, particularly to prevent young people to become smokers. The price of tobacco products has increased by 70%; it can avoid 1/4 of smoking death rate in the world. In addition, an increase in tobacco tax will not only help or reduce in tobacco production and consumption; it will also be a great solution to the shortage of national financial revenue problem. In high-income countries, 10% of the rate increase in tobacco products can reduce a consumption of tobacco by 4%.Whereas, in low-income countries it can reduce about 8% but tobacco taxes but will increase by almost 7%.For example, in the U.S. government make the federal tobacco tax from 39 cents per pack to $ 1.01, which is by far the most significant U.S. government to raise the federal tobacco tax. Select a recession in the domestic tobacco tax increase to help smokers to quit and this will be “great power”. Britain is the world’s that has highest tobacco tax. However, in 2009, the United Kingdom has doubled up the tobacco tax.
Price control is the import and export of goods or services on the enforcement of price-fixing measures. At the equilibrium price, there will be no shortage or surplus. The government may prefer to keep prices above or below the equilibrium. There will be a shortage, if government sets a maximum price below the equilibrium price. Price will not be allowed to rise to get rid of this shortage. This is called a ‘price ceiling’. There will be a surplus, if government sets a minimum price above the equilibrium price. Price will not be allowed to fall to get rid of this surplus. This is called a ‘price floor’.
For instance, fluctuation in weather can affect the crops. If industry demand is price inelastic, prices are possibility to fluctuate severely at a minimum price that can prevent a fall in producers’ incomes that would accompany periods of low prices. Whilst, if government sets a maximum prices to prevent them from rising above a certain level. This will generally be done for reasons of fairness. In wartime, or times of famine, the government may set maximum price for fundamental goods so that poor people can afford to buy the goods. Government keeps prices down for the consumers.
Besides that, subsidies are also other forms of public policies to overcome market failure. Government policies are very common in countries and it is benefit a lot of industries. Other than that, agriculture, education, free school meals, employment, state benefits, transport, working tax credits, regional development, housing are also some examples of the subsidies from government.
In the Egyptian economy, food subsidies can be affected in various sectors. A major objective of a research was done in order to examine the agricultural policy-making in the environment of a growing foods subsidy system. In addition, misallocation and in efficiencies of resources in agriculture take place when food subsidies are hidden costs of such systems. Nevertheless, it is a vital to divide out from the entire bundle of policy goals and relate it with those instruments that are directly or indirectly related to food subsidies. A complete quantitative evaluation of a country`s agricultural policy and its determinants can be provided by its basis. Furthermore, commodities that are strictly controlled on the production section are also strictly rationed at a fixed price on the food distribution are such as sugar and rice.
Product such as maize, wheat and meat are non-rationed or not strictly rationed commodities. Moreover, products that are not strictly rationed commodities are considerably to have less interference in allocation and marketing. The input and output prices of agricultural are distorted in different ways. Tax are usually taxed or given under the field of crops. Whereas, the production of milk and meat has been protected by the supply of subsidized and by import restrictions. Food policy may cause a consumer-to-producer to transfer and a producer-to-producer to transfer when a special situation for livestock or feed has been point out, in which it accompanies redistribution of income among the production sectors in an agriculture sectors.
In conclusion, as market failure will arise and government will established several policies to improve the market allocation. According to the cases as stated above, obviously, subsidies is the best effective policies that can be under take by market inefficiency. As it is the one of a positive solution and it can encourage producers to put more effort on producing and fully used the resources. The producers have no hesitation about accepting the government most generous offer. They are willing to produce maximum outfit by using subsidies that had given from the government. Hence, subsidies are no way to compare with other policies.
The free market system of resource allocation
‘People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices’ Adam Smith, Wealth of Nations, Book 10, Ch. VIII, (1776) Often, as Adam Smith noted above, the marketplace is influenced by the growth of monopolies, mergers, and cartel-type activities which often use their market power to the detriment of consumers. a) Examine the arguments in favour of a free market system of resource allocation (50 marks). b) Explain how ‘market failure’ can occur and suggest how the government in a country of your choice has sought to ‘correct’ those market failures (50 marks). Free market is a market in which there is the absence of economic interest and the various rules which are made by the government excluding stuffs like taxes, private contracts and the various rights of the land and home. It is some how the opposite of the controlled market where the government looks after the good and services and the mobility of labour , the price and the distribution rather than looking after the private ownership. Free market generally focuses on the fact that the production is solely private and not under government. Here free market is economy where the government doesn’t limit (by controlling the firms from internal and external market pressure) or promote (by contributing the subsidies) the administration and legislation of economic activity. (Annual Report, 2009) The free trade theory supports the idea of free market where the property is exchanged with price set by the sellers and buyers without harming each others property right. in this method the buyers are sellers are happy it the transaction .they simply get into trade with each other with the set price where there is no involvement of any third party such as government via transfer payment and without the use of physical power. The price is the reason for supply and demand in the market. Market is a place where the price of the products or services determines the allocation of resources to consumer satisfaction.
The arguments in the favour of free market system are: Adapt changes: As the demand for people needs changes day by day. Those commodities which are on high demand for particular product increases then they can start to produces those commodities which meets the needs of people today to rather than taking too long through government procedure. Since the demand changes they should able to produce those commodities which can satisfy the peoples current need.
. Leads to innovation: The free market often leads to innovation. There is variety of new produces introduced in the market day by day to meet the requirement. The free market leads to innovation of new production to satisfy the needs of consumers which is changeable time to time. (Smith,2008) The often tend to produce unique items whose demand increases as they are newly introduced in the market. The market also encourages the new products and better innovative machines and methods for new commodity.
Competitive environment: There is a huge competition in the market who create variety of products in the market .Market is a place where various commodities are produced to satisfy the need of people. People in the market produce new items day by day. They deal in a very competitive environment between the producers as everyone tends to produce new products. One should always look to produce items which can satisfy the customer’s current need.
Creates employment: The free make creates employment in the market. They provide various chance of employment as they are paid more moderately on the quality of work you tend to do. And they tend to have better pay rates for the people.
Market is the cause of demand and supply not a monopoly: Market is affected by the demand of a particular products and the supply of theses commodities rather than a monopoly. Its is based on the demand and supply not a owner of a company and there exist no monopoly. The seller is the one who decides the price, and the quantity to be supplies in the result of demand.
Cheaper rates: The commodities in the market are generally cheaper. The customer can have access to all different kinds of commodities at cheaper price rather than buying it else where at a high price. (Webforum.2006) They tend to be cheaper as there is no tax, subsidies on the product and the price should also be agreed by the seller and the buyer.
Right to choice: The customers have the right to choose at a free market. They can purchase the commodities which meet their demand and can also make a choice from variety of products. The have the full right to make purchase on the good they chose with the mutual understanding of the seller for price.
Market limits carefulness and authority: In a Free market in a competitive market the player has no right to determine the prices and no player have power over anything in the market. The systems keep on changing and one has control over it. (Collins,2011) People are more concerned about the growing rise in the firm.
Market Failure Market failure is market situation where the distribution of commodities in a free market is not well organized. Market failure can take place when the individuals take a selfish step to benefit them which however can be improved. Market failures are generally related with the non competitive market, externalities and public supplies. The market failure can also be taken as a good cause for government involvement in a particular market. (Annual report, 2007)The various types of taxes, subsidies, price control and policies including the method to correct the market failure can cause unproductive allocation of resources.
The various reasons for market failure can be summarized as: Short term and long term environmental concerns: The various deed of the agent can also lead to few externalities which are instinctive to production methods or few environments vital to the market. For example a steel producer captures is labour, capital and inputs and it is liable to pay to these at their respective market and those cost will be remarked in the steel price in the market. If they firm tends to harm the environment during steel production and if the firms are not made to pay for the use of resources ten the society is bound to pay for it.
Lack of public goods: Lack of goods is when the government doesn’t provide the goods which are not found adequately free market. Preferably the government would make available all the good s that is not adequately found in a free market. Market failure takes place because the market fails with no public goods, however people won’t tend to buy theses as they are not profitable. Government are good source for preventing market failure (Economist.com,2010)
Abuse of monopoly power: Monopolies have the full right to determine the price a commodity. High demanded commodity can be elastic as it will be ready to pay many price for it. Due to the inelastic good the price tend to rise causing a market failure as the supply isn’t inflated by the competition.
Externalities: Externalities are not the cost of benefit of consumption made by the third party however produces nor can consumers cause them. Positive externalities are goods that cause benefit to the third party who don’t pay to receive theses benefits. They are low priced and under produced. Negative externalities are goods that enforce cost to third parties who are not involved. These are over produced goods that have low prices.
The steps taken by to stop market failure are: Direct provision of merits and public goods: Merits and public goods often lead to market failure as people generally are not willing to pay for it. (Westerfield, 2010) difficult o exist in this condition if UK is directly providing the commodity to customers there can be no market failure and also improves the infrastructure.
Legislation: It is a set rule by the government of a country. It also deals with the market failure and to reduce the negative externalities and increases the directive of the commodities accountable to it with high price and low quantity.
Taxation: This occurs when UK government increase the commodity price by imposing tax on the consumption of the good. High tax rate can decrease the consumption as less people will be willing to buy it at high rates. This creates competition in business and even substitute can occur due to price rise.
Subsidies: With a good that has positive externalities the government tend to produce a subsidies to prevent market failure. This solely means the government will seek help from, the party that produces those externalities to increase production. When subsidies are specified then producers tend to produce more due to more capital with the marginal private benefit closer to marginal social benefit, with reduction in the positive externalities and stopping market failure.
International cooperation among governments: The government and the organization bind to solve the externalities. the focal point is to create methods to equalize the marginal cost and marginal private cost . This however can’t be a beneficial as other method. UK should have monopoly with other countries on particular items so that they can benefit as well.
Advertising to encourage or discourage consumption: Advertisement can be used to encourage or discourage consumption or production of those goods which can be positive negative externalities. Whenever there is deficit in the market the government persuade consumption or production, if a surplus is measure then the government dampen the consumption or production. (Holland, 1987) Talking about climate change in UK it is a result of pollution. To alert the people they do various advertisements or add to inform people about it. Commodities having positive externalities are created properly so governments what to increase the consumption of it where those over produced goods are discouraged
PART B The problems in the global banking system have affected most major economies of the world. In response, governments have introduced monetary and fiscal policies to try to improve the situation. With reference to a country of your choice:- a) Examine how the government of that country has adjusted its monetary and fiscal policy in response to the world downturn. Explain the reasoning behind these adjustments. (50 marks) b) Indicate the problems which are created for the government’s finances as a result of it seeking to avoid an even deeper recession. (50 marks) Recession can be defined as a situation where decline in economic activity takes place however it is shorter than depression. Recession effects the employment, inflation, incomes, spending capacity of people, profits from business and also leads to bankruptcies of few organizations. The recession has also majorly affected the economic sector such as house market, retail industry and also leads to bankruptcy for few banks. (Fargo,2002)
The Government of UK has taken various steps to stop the recession and they are: Encourage imports of high priced commodities: The UK import and export has been ranked as the 6th in terms of exports and ranks 4th on the imports. The high priced commodities like the food products are always high in price and have been imported from various countries like middle east, Asia , US and Europe by imposing good amount of tax on them so that in brings stability on the price.
Fig: foreign trade from 1992-2002 Geroski