Question

2.) Briefly describe how each of the following results in market failure. a. Monopoly b. Externalities c. Asymmetric Information

Answer 1

Answer for 2 (a):

As per the given data & information

Monopoly:

Agents in a market can gain market power, allowing them to block other mutually beneficial gains from trade from occurring. This can lead to inefficiency due to imperfect competition, such as monopolies, if the agent does not implement perfect price discrimination.

It is then a further question about what circumstances allow a monopoly to arise. In some cases, monopolies can maintain themselves where there are "barriers to entry" that prevent other companies from effectively entering and competing in an industry or market. Or there could exist significant first-mover advantages in the market that make it difficult for other firms to compete.

Moreover, monopoly can be a result of geographical conditions created by huge distances or isolated locations. This leads to a situation where there are only few communities scattered across a vast territory with only one supplier.

Australia is an example that meets this description.A natural monopoly is a firm whose per-unit cost decreases as it increases output; in this situation it is most efficient (from a cost perspective) to have only a single producer of a good. Natural monopolies display so-called increasing returns to scale.

It means that at all possible outputs marginal cost needs to be below average cost if average cost is declining. One of the reasons is the existence of fixed costs, which must be paid without considering the amount of output, what results in a state where costs are evenly divided over more units leading to the reduction of cost per unit.

Answer for 2 (b):

As per the given data & information

Externalities:

When goods are produced, they may create consequences that no one pays for. Such unaccounted-for consequences are called externalities.

Because externalities are not accounted for in the costs and prices of the free market, market agents will receive the wrong signals and allocateresources toward bad externalities and away from good externalities.However, because the costs of those externalities are not accounted for in the price of the good, the price is lower than it should be, and too much of the good is consumed and produced.

In both cases, the market has failed to reach efficiency, because it has allocated resources and production without considering the externalities. Classic examples of bad externalities include industrial pollution and traffic congestion. Industrial pollution has harmful effects on people and the environment. Yet the cost of producing goods does not include the cost of dealing with the effects of pollution. This means that, in the free market, producers are responding to costs that are too low, and consumers are facing prices that are too low. More goods are produced and sold in the free market than should be, given the negative social effects of pollution.

Answer for 2 (c):

As per the given data & information

Asymmetric information:

Consumers, producers and resource owners have perfect knowledge about market conditions under perfect competition. But in the real world, there is asymmetric or incomplete information due to ignorance and uncertainty on the part of buyers and sellers of goods and services.

Thus they are unable to equate social and private benefits and costs this is because consumers are ignorant about the quality of goods that they buy benefits of goods.

Similarly, firms are ignorant and uncertain about future prices costs sales, actions of rivals, etc. In some cases, information about market behaviour in the future may be available but that may be insufficient or incomplete. Thus market failure is inevitable.

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