Efficiency and Market Failure

Causes of Market Failure: Missing Markets

A market is generally considered efficient when it allocates resources in a way that maximizes overall welfare. However, real-world markets often fail to achieve this ideal due to various factors. One significant cause of market failure is the existence of missing markets. A missing market occurs when a good or service that would normally be traded in a market is not available or is not traded efficiently.

What are Missing Markets?

Missing markets can arise for several reasons. They can be due to legal restrictions, information asymmetry, difficulties in defining property rights, or the inherent characteristics of the good or service itself.

Types of Missing Markets

We can categorize missing markets into several types:

• Externalities: While externalities are often considered a separate type of market failure, they can also lead to a situation where a market effectively "misses" the true social cost or benefit of a good or service.
• Public Goods: Goods that are non-rivalrous (one person's consumption doesn't diminish another's) and non-excludable (it's impossible to prevent people from consuming the good) are classic examples of missing markets. Private markets struggle to efficiently provide public goods.
• Information Asymmetry: When one party in a transaction has more information than the other, a market may not function efficiently. This can lead to adverse selection and moral hazard.
• Contractual Limitations: Difficulties in drafting and enforcing contracts can prevent mutually beneficial exchanges from occurring.

Examples of Missing Markets

1. Public Goods (National Defence): National defence is a quintessential public good. It's non-excludable – everyone benefits regardless of whether they pay – and non-rivalrous – one person's benefit doesn't diminish others'. Private firms are unlikely to supply national defence because they can't easily charge for it.
2. Basic Research: The benefits of basic research (e.g., scientific discoveries) are often enjoyed by society as a whole, but it's difficult to capture the full value in a private market. Individuals and firms may under-invest in basic research because they can't easily profit from it.
3. Certain Medical Services: Some medical services, particularly those addressing neglected diseases or those requiring specialized expertise, may not be adequately provided by private markets due to low profitability or high risk.
4. Environmental Goods: Clean air and water are examples of goods that are often treated as missing markets. Because they are non-excludable, private firms have little incentive to ensure their availability.

Consequences of Missing Markets

The absence of efficient markets for certain goods and services can lead to:

• Under-provision of goods and services: Essential goods and services may not be available in sufficient quantities.
• Inefficient resource allocation: Resources may be allocated to less valuable uses.
• Reduced overall welfare: Society's overall well-being can be diminished.

Government Intervention

Governments often intervene to address missing markets. Common interventions include:

• Provision of Public Goods: Governments directly provide public goods like national defence, street lighting, and law enforcement.
• Subsidies: Governments can provide subsidies to encourage the production and consumption of goods that are under-provided by private markets (e.g., subsidies for renewable energy).
• Regulation: Regulations can be used to address information asymmetry and ensure quality standards (e.g., food safety regulations).
• Property Rights Clarification: Defining and enforcing property rights can facilitate market transactions that were previously impossible.

Type of Missing Market	Example	Potential Government Intervention
Public Goods	National Defence	Direct Provision by the Government
Basic Research	Scientific Discoveries	Government Funding for Research Institutions
Environmental Goods	Clean Air and Water	Regulations and Pollution Control Measures