Inefficient Resource Allocation & Market Failure (Edexcel IGCSE Economics)
Exam board Pearson Edexcel · IGCSEUpdated 2024-04-12
Understanding Market Failure
Spec point —
1.1.5e
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In a free market, the price mechanism determines the most efficient allocation of scarce resources
- Scarce resources are the **factors of production **(land, labour, capital, and enterprise)
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Free markets often work very well, matching the** competing wants and needs** in the marketplace
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However, the free market sometimes leads to market failure
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This occurs when there is a less than optimal allocation of resources from society’s point of view
- If resources were allocated in a different way, more output could be produced
- When the free market causes a lack of equity (inequality) or environmental degradation
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Market Failure & Government Intervention
Spec point —
1.1.5e
- Market failure occurs when free market activity results in a less than optimum allocation of resources from the point of view of society
Diagram: Causes of Market Failure
Market failure includes demerit, merit & public goods, abuse of monopoly power, factor immobility & externalities
Explanation of causes of Market Failure and Government Intervention
| Cause | Explanation | Government Intervention |
|---|---|---|
| Demerit goods | - These are goods which have harmful impacts on consumers or society as a whole - They are often addictive - E.g. Gambling, alcohol, drugs, sugary foods and drinks | - They are over-provided in a market and their consumption often creates external costs - Governments often have to regulate these goods in such a way that they raise the prices or limit the quantities consumed |
| Merit goods | - These are goods that are beneficial to society but consumers under-consume them as they do not fully recognise the private or external benefits - E.g. Vaccinations, education, electric cars | - They are under-provided in a market, and their consumption generates both private and/or external benefits - Governments often have to subsidise these goods in order to lower the price or increase the quantities consumed |
| Public goods | - Public goods are beneficial to society but would be under-provided by a free market - There is little opportunity for sellers to make profits from providing them, as they are non-excludable and non-rivalrous in consumption - Good examples include national defence, parks, libraries and lighthouses | - Non-excludability refers to the inability of private firms to exclude certain customers from using their products. In effect, the price mechanism cannot be used to exclude customers, e.g. street lighting - Non-rivalry refers to the inability of the product to be used up, so there is no competitive rivalry in consumption to drive up prices and generate profits for firms - Therefore, governments will often provide these beneficial goods themselves, and so they are called public goods |
| Abuse of monopoly power | - The development of monopoly markets is a natural outcome of a market system - Firms seek to eliminate competition by buying out competitors and increasing their ownership of factors of production - With less competition, firms can raise prices, reduce the choice available to consumers, or limit the supply | - The outcome is that goods and services are purposely under-provided in order to raise prices and profits - Governments often intervene to ensure that there is healthy competition in markets and sufficient provision of goods and services |
| Factor immobility | - Factor immobility occurs when it is difficult for factors of production to move or switch between different uses or locations - The two main types of factor immobility are the geographical and occupational immobility of labour | - Factor immobility results an inefficient allocation of resources in a market (usually under-provision) - Governments often implement programs to reduce the factor immobility in order to raise production and output - E.g. Support relocation of workers when one industry closes down in a particular area |
| Externalities | - Externalities occur when there is an external cost or benefit on a third party not involved in the economic transaction - These impacts can be positive or negative - The price mechanism in a free market ignores these externalities - If these external costs/benefits were acknowledged, the price and output in the market would be different | - Generally, governments will seek to subsidise products which have positive externalities (or provide the product themselves) - Generally, governments will seek to tax products which have negative externalities (or limit their output through regulation) |
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