Market Efficiency and Market Failure

Efficiency in Competitive Markets

• Allocative and Productive Efficiency: Achieved in competitive markets, leading to maximum economic surplus.
• Deadweight Loss: Occurs from underproduction and overproduction.

Market Failure

• Definition: When markets don't lead to an efficient outcome.
• Misconception: Market failure is not just about not getting desired goods at low prices.

Reasons for Market Failure

1. Externalities

   • Choices of buyers/sellers don’t reflect full costs and benefits.
   • Example: Driving benefits vs. pollution costs.
   • Leads to overproduction when true marginal cost isn't considered.

2. Government Failure

   • Inefficiencies created by government regulations.
   • Causes underproduction, overproduction, and deadweight loss.

3. Market Power

   • Occurs when a company has pricing power, like a monopoly.
   • Affects efficiency due to lack of competition.

4. Asymmetric Information

   • Markets need transparent costs/benefits for efficiency.
   • Example: Hidden information in used car sales.
   • Influences price accuracy.

5. Irrationality

   • Systematic decision-making errors.
   • People may not follow true marginal costs and benefits.
   • Studied in behavioral economics.

The Role of Government

• Markets are generally efficient but not flawless.
• Government may provide solutions but can also fail and worsen situations.
• Government action involves self-interest and choice, leading to potential inefficiencies.