Answer to Question #59882 in Economics of Enterprise for akan

Question

Externalities and public goods are examples of market failures. Explain why these are market failures. Also, provide two ideas to help solve each of these two market failures and why/how your ideas will work.

Answer 1

Market failure is a situation in which the allocation of goods and services is not efficient. A market failure can occur for three main reasons: if the market is "monopolized" or a small group of businesses hold significant market power, if production of the good or service results in an externality, or if the good or service is a "public good".
A good or service could have significant externalities, where gains or losses associated with the product, production or consumption of a product because it differs from the private cost.
A public good is a good that is both non-excludable and non-rivalrous in that individuals cannot be effectively excluded from use and where use by one individual does not reduce availability to others

In order to reduce or eliminate market failures, governments can choose two basic strategies:
1) Use the price mechanism (increasing the price of ‘harmful’ products, through taxation, and providing subsidies for the ‘beneficial’ products).
2) Use legislation and force (banning cars from city centers, or having a licensing system for the sale of alcohol, or by penalising polluters, the unwanted behavior may be controlled).