Market Failure: Reasons and Consequences

Introduction

Market failure occurs where free markets fail to allocate scarce resources efficiently. Market failure can come in many forms, the main four are public goods, merit goods, externalities, and imperfect competition. In this report, I will investigate the relationship between these four main factors and the free market.

Public Goods

Public goods are goods and services that cannot be efficiently provided by the private sector. They can be classified as pure public goods and quasi-public goods. Pure public goods are not at all provided by the private sector – hence there is a market failure due to ‘missing markets’. This is partly due to the ‘free rider’ principle – i.e., people can access, consume, and benefit from public goods without being required to pay for them (Samuelson, 1954). Pure public goods have two standout characteristics:

• Non-rival – consumption of the good by one person does not reduce the amount available for consumption by another person. E.g., terrestrial television services provided by the BBC.
• Non-excludable – it is not possible to provide a good or service to one person without it being available for others to enjoy. If non-payers cannot be excluded, a profit-motivated business may decide not to supply these products, e.g., defense systems, lighthouse protection (Musgrave, 1959).

Quasi-public goods are goods that are not purely public; they are public in nature but do not fully display the characteristics of non-excludability and non-rivalry. An example of this would be roads, which may become rivals at peak times.

Merit Goods

Merit goods are goods and services deemed socially desirable, which are expected to be under-produced and under-consumed. Examples of merit goods include education, healthcare, welfare services, and public parks. Unlike pure public goods, merit goods could be, and indeed are, provided through the market but not necessarily in sufficient quantities to maximize social welfare. Merit goods tend to be underprovided by the market because:

• They generate positive externalities (Arrow, 1963).
• There is an unequal distribution of income.
• Consumers may lack perfect information.
• Consumers may be uncertain about their future needs.

Externalities

An externality is an impact on a person not connected to the initial transaction. It arises when a person engages in an activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect (Pigou, 1920). When the effect on the bystander is unfavorable, the externality is called a negative externality. When the effect is beneficial, it is called a positive externality.

Positive externalities include:

• Education
• Perfume
• Parks

Negative externalities include:

• Pollution
• Anti-social behavior

Imperfect Competition

Imperfect competition is a competitive market situation where there are many sellers, but they sell heterogeneous (dissimilar) goods, as opposed to the perfectly competitive market scenario. As the name suggests, these markets deviate from perfect competition (Chamberlin, 1933). Imperfect competition is prevalent in the real world, with many industries and sellers following it to earn surplus profits. In this market scenario, sellers enjoy the luxury of influencing prices to earn more profits. If a seller offers a nonidentical good, they can raise prices and earn profits. High profits attract other sellers to enter the market, while those incurring losses can easily exit.

There are four types of imperfect markets:

• Monopoly (only one seller)
• Oligopoly (few sellers of goods)
• Monopolistic competition (many sellers with highly differentiated products)
• Monopsony (only one buyer of a product)

Universal Credit

Universal Credit is a government policy on welfare. It was introduced to replace six benefits: child tax credit, housing benefit, income support, income-based jobseeker’s allowance, income-related employment and support allowance, and working tax credit. The initial idea was outlined by the Work and Pensions Secretary Iain Duncan Smith at the Conservative Party annual conference in 2010. The aim was for the policy to be fully implemented over four years and two parliaments, merging the aforementioned benefits. Universal Credit was introduced to streamline the benefits system, making it easier to claim benefits as individuals only had to apply once rather than six times.

Universal Credit was part of the 2012 Welfare Reform Act. It works by providing one monthly payment consisting of a basic ‘standard allowance’ and extra payments that might apply depending on the claimant's circumstances. With Universal Credit, there is a 7-day waiting period without payment, followed by a potential wait of up to seven weeks for the first payment.

There has been significant criticism of Universal Credit, mainly regarding the long waiting period between application and the first payment. The government claims this time is necessary to assess the claim. During this period, individuals who rely on government support for rent have to pay it themselves, potentially leading to serious debt. According to figures obtained by the Labour Party, half of all council tenants on Universal Credit are at least a month in arrears with their rent (Smith, 2015).

Conclusion

Universal Credit has been regularly criticized by newspapers and opinion shows due to the prolonged wait between application and payment. Research indicates that people waiting for payments have fallen into debt, and when the payment does eventually come through, they must allocate a portion of that money to try to recover from debt (Jones, 2018). The complex interplay of market failures and governmental interventions underscores the challenges of achieving an efficient allocation of resources in an economy.