Micro Economics Chapter Summary

¶ … government intervention through examining the meaning of market failure, reasons the market under-produces public goods, how externalities result in distortion of market outcomes, how market power prevents optimal results, and policy options for government interventions. The author considers market failure as the what question that contributes to the potential for government intervention in order to generate the most appropriate combination of output with present resources. Through an analysis of the nature of market failure, the term is used to describe less than perfect or suboptimal outcomes. The concept implies that supply and demand forces have not contributed to the realization of the best point on the production-possibilities curve.

Since it's a justification for government intervention, market failure is brought by various microeconomic factors such as public goods, externalities, market power, and inequity. This implies that market failure can be understood through examining these micro-economic sources or factors. Moreover, government intervention towards microeconomic market failure should primarily be centered on these sources.

Based on unique market mechanism that indicate consumer demands for several products and services, the market tend to under-produce public goods. Public goods can be defined as the various products and services manufactured in the public domain and consumed jointly by those who pay for them and those who don't. In most cases, the market under-produces public goods because of the principle of exclusion based on technical considerations instead of political philosophy. The market produces certain goods and services only to individuals who purchase the product and service rather than non-payers as a means of promoting the efficiency of market mechanism (Shiller, 2009, p.185).

As a major factor in market failure, externalities distort market outcomes, which results in market failure. Externalities provide justification for government intervention because of the tendency of costs and benefits of certain market activities to spill over onto third parties. As a result, externalities can be defined as the benefits or costs of a market activity borne by an individual other than immediate producer or consumer i.e. A third party. They distort market outcomes by inhibiting the complete measure of the value of a product to the society based on preferences expressed in the marketplace. Consequently, the market will eventually fail to generate the right output mix, which distorts its outcomes.

Market power is a source of market failure that is brought by a flawed response because of flawed market price signal. While market power is also caused by other factors, it creates a mechanism where producers obtain discretionary power over the reaction of the market to price signals. These producers are likely to use the discretion to enrich themselves instead of using them to promote economic growth and result in the optimal output mix. Therefore, market power prevents the realization of optimal outcomes by giving some producers discretionary power over the reaction of the market to price signals.