No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Thirteen: Market “Failure” and the Role of the Government 302 INTRODUCTION The term “market failure,” when heard by economists, often causes them to ask, “as compared to what?” Market failure simply means that markets fail to meet some standard. What is that standard, and is that standard appropriate? Often times the standard suggested is the perfectly competitive (or price taker) model we reviewed in chapter 8; if prices and quantities differ from that model it is inefficient. We will expand on this discussion later, but it’s useful to remember that we must compare reality to reality, or theory to theory. To say that because real world markets fail to meet some theoretical reality doesn’t mean they really fail— if markets are better than any other possible real world institutional arrangement. We need to keep in mind that utopias (heaven on earth) are not compatible with a Christian worldview. While we may be able to improve the world we live in (and definitely should try to do so), we are also well aware that changes can make things worse as well as better. So in order to consider possible market failure, let’s first think about what we would like them to do in order to be efficient. EFFICIENCY OF MARKETS In chapter 5, we introduced the market process through supply and demand and we learned that markets provide incentives for people to make socially optimal choices. When a natural disaster strikes oil platforms in the gulf coast, for example, the price of gasoline will rise, causing some users to reduce their consumption of gasoline. Further, the increased price of gas will cause some suppliers to reduce inventories and producers to expand production. Both on the supply side and the demand side, the price system encourages socially beneficial action by market participants. In Figure 13.1 , we see the equilibrium condition that markets tend to work towards. If we have a quantity less than the equilibrium condition (Q*), units are more highly valued by the consumers than the opportunity costs of the resources used to produce them. If you look at Figure 13.1 , you can see that to the left of Q*, every point on the demand curve is at a higher price than a corresponding point on the supply curve. So the socially efficient action would be for producers to produce more for sale, until we get to the equilibrium quantity. If the equilibrium quantity is exceeded, then the cost of the resources used to produce the good or service are more highly valued in producing something else. Producing where costs are greater than Producing where costs are greater than benefits is inefficient, since the output is valued less than its opportunity cost. P ($) Q (#) Q * P * S D Figure 13.1, Market Equilibrium is Efficient. Markets tend to lead to efficient results because every item that is valued by consumers (as represented by the marginal benefit inherent in the demand curve) greater than the cost of the inputs used to produce the item (represented by the supply curve) are produced and value is created in exchange. Likewise, producers that provide a product that costs more to produce than people value it will suffer loss.