Editing Market failure (section)

==Categories==
Different economists have different views about what events are the sources of market failure. Mainstream economic analysis widely accepts that a market failure in relation to several causes.<ref>J Stiglitz and J Rosengard, Economics of the Public Sector (4th edn 2015) chapter 4, 83-94. T Piketty, ''Capital in the Twenty-First Century (2011) ch 9. D Kahneman, ''Thinking, Fast and Slow'' (2011)</ref> These include if the market is "[[monopolised]]" or a small group of businesses hold significant [[market power]] resulting in a "failure of competition"; if production of the good or service results in an [[externality]] (external costs or benefits); if the good or service is a "[[Public good (economics)|public good]]"; if there is a "failure of information" or [[information asymmetry]]; if there is [[unequal bargaining power]]; if there is bounded rationality or irrationality; and if there are macro-economic failures such as unemployment or inflation. 

===Failure of competition===
{{main|Market structure|market power|}}
[[Agent (economics)|Agent]]s 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]], which can take many different forms, such as [[Monopoly|monopolies]],<ref name="demartino01">{{cite book |title=Global Economy, Global Justice |last=DeMartino |first=George |year=2000 |publisher=Routledge |isbn=0415224012 |page=70 |url=https://books.google.com/books?id=bh66WFcdT9sC}}</ref> [[monopsonies]], or [[monopolistic competition]], if the agent does not implement perfect price discrimination.

[[File:NIGU transmision line near Te Kauwhata.JPG|thumb|270px|In small countries like [[New Zealand]], [[electricity transmission]] is a natural monopoly. Due to enormous [[fixed cost]]s and small [[Market (economics)|market size]], one seller can serve the entire market at the downward-sloping section of its [[Cost curve#Short-run average total cost curve (SRATC or SRAC)|average cost curve]], meaning that it will have lower average costs than any potential entrant.]]

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 advantage]]s 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.<ref name=":0">{{Cite book|title=The political economy of local government|last=Brian.|first=Dollery|date=2001|publisher=Edward Elgar Pub|others=Wallis, Joe (Joe L.)|isbn=1840644516|location=Northampton, MA|oclc=46462759}}</ref> 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.<ref>{{Cite web|url=http://www.economicsonline.co.uk/Business_economics/Natural_monopolies.html|title=Natural monopolies exist when one firm dominates an industry|website=www.economicsonline.co.uk|access-date=2018-04-24}}</ref>

===Public goods===
Some markets can fail due to the nature of the goods being exchanged. For instance, some goods can display the attributes of [[public goods]]<ref name="demartino01" /> or [[common good]]s,<ref>{{Citation|last=Hussain|first=Waheed|title=The Common Good|date=2018|url=https://plato.stanford.edu/archives/spr2018/entries/common-good/|encyclopedia=The Stanford Encyclopedia of Philosophy|editor-last=Zalta|editor-first=Edward N.|edition=Spring 2018|publisher=Metaphysics Research Lab, Stanford University|access-date=2020-10-31}}</ref> wherein sellers are unable to [[Excludability|exclude]] non-buyers from using a product, as in the development of inventions that may spread freely once revealed, such as developing a new method of harvesting. This can cause underinvestment because developers cannot capture enough of the benefits from success to make the development effort worthwhile. This can also lead to [[resource depletion]] in the case of [[common-pool resource]]s, whereby the use of the resource is [[Competition|rival]] but [[Excludability|non-excludable]], there is no incentive for users to conserve the resource. An example of this is a lake with a natural supply of fish: if people catch the fish faster than the fish can reproduce, then the fish population will dwindle until there are no fish left for [[future generations]].

===Externalities===
A good or service could also have significant [[Externality|externalities]],<ref name="Laffont" /><ref name="demartino01" /> where gains or losses associated with the product, production or consumption of a product, differ from the private [[cost]]. These gains or losses are imposed on a third-party that did not take part in the original market transaction. These externalities can be innate to the methods of production or other conditions important to the market.<ref name="krugman" />

"The Problem of Social Cost" illuminates a different path towards social optimum showing the [[Pigouvian tax]] is not the only way towards solving externalities. It is hard to say who discovered externalities first since many classical economists saw the importance of education or a lighthouse, but it was Alfred Marshall who wanted to explore this more. He wondered why long-run supply curve under perfect competition could be decreasing so he founded "external economies" (<ref>Sandmo 228</ref><ref>{{cite book |last1=Sandmo |first1=Agnar |title=Economics evolving : a history of economic thought |date=2011 |publisher=Princeton University Press |location=Princeton, N.J. |isbn=9780691148427 |pages=228 }}228</ref>). Externalities can be positive or negative depending on how a good/service is produced or what the good/service provides to the public. Positive externalities tend to be goods like vaccines, schools, or advancement of technology. They usually provide the public with a positive gain. Negative externalities would be like noise or air pollution. Coase shows this with his example of the case ''Sturges v. Bridgman'' involving a confectioner and doctor. The confectioner had lived there many years and soon the doctor several years into residency decides to build a consulting room; it is right by the confectioner's kitchen which releases vibrations from his grinding of pestle and mortar (<ref>The Problem of Social Cost 8</ref><ref>{{cite book |last1=Coase |first1=Ronald |title=The Problem of Social Cost |date=1960 |publisher=The University of Chicago Press |location=Chicago |isbn=9781539433408 |pages=8 }}</ref> ). The doctor wins the case by a claim of nuisance so the confectioner would have to cease from using his machine. Coase argues there could have been bargains instead the confectioner could have paid the doctor to continue the source of income from using the machine hopefully it is more than what the Doctor is losing (<ref>The Problem of Social Cost 9</ref><ref>{{cite book |last1=Coase |first1=Ronald |title=The Problem of Social Cost |date=1960 |publisher=The University of Chicago Press |location=Chicago |isbn=9781539433408 |pages=9 }}</ref> ). Vice versa the doctor could have paid the confectioner to cease production since he is prohibiting a source of income from the confectioner. Coase used a few more examples similar in scope dealing with social cost of an externality and the possible resolutions.

[[File:6th Avenue from 49th.jpg|thumb|300px|Congested [[Avenue of the Americas]] in [[Midtown Manhattan|Midtown]] [[Manhattan]], [[New York City]], which leads the world in urban automobile traffic congestion,<ref name=NYCCongestion>{{cite web|url=https://www.economist.com/united-states/2024/11/21/congestion-pricing-in-new-york-gets-the-go-ahead-after-all-maybe|title=Congestion pricing in New York gets the go-ahead after all. Maybe|publisher=The Economist|date=November 21, 2024|access-date=November 21, 2024|quote=But traffic is bad most days, with more than 900,000 cars entering Manhattan’s central business district. INRIX, a traffic-data firm, found that New York City leads the world in urban traffic congestion among the cities scored, with the average driver stationary for 101 hours a year.}}</ref> but which has implemented [[Congestion pricing in New York City|congestion pricing]] in January 2025 to address the gridlock]]
[[Traffic congestion]] is an example of market failure that incorporates both non-excludability and externality. Public roads are common resources that are available for the entire population's use (non-excludable), and act as a [[Complementary good|complement]] to cars (the more roads there are, the more useful cars become). Because there is very low cost but high benefit to individual drivers in using the roads, the roads become congested, decreasing their usefulness to society. Furthermore, driving can impose [[hidden costs]] on society through pollution (externality). Solutions for this include [[public transport]]ation, [[congestion pricing]], tolls, and other ways of making the driver include the [[social cost]] in the decision to drive.<ref name="krugman" />

Perhaps the best example of the inefficiency associated with common/public goods and externalities is the environmental harm caused by [[pollution]] and [[overexploitation]] of [[natural resource]]s.<ref name="krugman" />

====Coase theorem====
The [[Coase theorem]], developed by [[Ronald Coase]] and labeled as such by George Stigler, states that private transactions are efficient as long as property rights exist, only a small number of parties are involved, and transactions costs are low. Additionally, this efficiency will take place regardless of who owns the property rights. This theory comes from a section of Coase's Nobel prize-winning work ''[[The Problem of Social Cost]]''. While the assumptions of low transactions costs and a small number of parties involved may not always be applicable in real-world markets, Coase's work changed the long-held belief that the owner of [[property rights]] was a major determining factor in whether or not a market would fail.<ref>Michael Parkin (2008). ''Microeconomics'', 9th Ed. p. 379. University of Western Ontario.</ref> The Coase theorem points out when one would expect the market to function properly even when there are externalities.

<blockquote>A market is an institution in which individuals or firms exchange not just commodities, but the ''rights'' to use them in particular ways for particular amounts of time. [...] Markets are institutions which organize the ''exchange of control'' of commodities, where the nature of the control is defined by the property rights attached to the commodities.<ref name="rees"/></blockquote>

As a result, agents' control over the uses of their goods and services can be imperfect, because the system of rights which defines that control is incomplete.  Typically, this falls into two generalized rights – ''excludability'' and ''transferability''.  Excludability deals with the ability of agents to control who uses their commodity, and for how long – and the related costs associated with doing so.  Transferability reflects the right of agents to transfer the rights of use from one agent to another, for instance by selling or [[leasing]] a commodity, and the costs associated with doing so.  If a given system of rights does not fully guarantee these at minimal (or no) cost, then the resulting distribution can be inefficient.<ref name="rees"/> Considerations such as these form an important part of the work of [[institutional economics]].<ref name="bowles">{{cite book | last = Bowles  | first = Samuel | title = Microeconomics: Behavior, Institutions, and Evolution | publisher = Russel Sage Foundation
  | year = 2004  | location = United States}}</ref> Nonetheless, views still differ on whether something displaying these attributes is meaningful without the information provided by the market price system.<ref>Machan, R. Tibor, [http://media.hoover.org/documents/0817929428_xi.pdf ''Some Skeptical Reflections on Research and Development''], Hoover Press</ref>

===Information failures===
[[Information asymmetry|informational asymmetry]] is considered a leading type of market failure.<ref>J Stigitz and J Rosengard, ''Economics of the Public Sector'' (2015) ch 4, 87-93</ref><ref name="krugman"/><ref name="demartino01" /> This is where there is an imbalance of information between two or more parties to a transaction. One example is [[incomplete markets]], for example where second hand car buyers know there is a risk a car may break down, and systematically under-pay to discount this risk: this leads to fewer cars being sold overall; or where insurers know that some policyholders will withhold information, and systematically refuse to insure certain groups because of this risk. This may result in economic inefficiency, but also have a possibility of improving efficiency through market, legal, and regulatory remedies. From [[contract theory]], decisions in transactions where one party has more or better [[information]] than the other is considered "asymmetry". This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry. Examples of this problem are [[adverse selection]]<ref>{{Cite journal|last1=Finkelstein|first1=Amy|last2=Poterba|first2=James|date=2004|title=Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market|url=http://papers.nber.org/papers/w8045.pdf|journal=Journal of Political Economy|volume=112|issue=1|pages=183–208|doi=10.1086/379936|jstor=10.1086/379936|s2cid=14608232 }}</ref> and [[moral hazard]]. Most commonly, information asymmetries are studied in the context of [[principal–agent problem]]s. [[George Akerlof]], [[Michael Spence]], and [[Joseph E. Stiglitz]] developed the idea and shared the 2001 Nobel Prize in Economics.<ref>{{cite journal|last=Huffman |first=Max|title=Neo-Behavioralism?|date=December 2010|page=9|ssrn=1730365}}</ref>

===Unequal bargaining power===
{{main|Inequality of bargaining power}}
In ''The Wealth of Nations'' [[Adam Smith]] explored how an employer had the ability to "hold out" longer in a dispute over pay with workers because workers were more likely to go hungry more quickly, given that the employer has more property, and have fewer obstacles in organising.<ref>A Smith, ''The Wealth of Nations'' (1776) Book I, chapter 2</ref> Unequal bargaining power has been used as a concept justifying economic regulation, particularly for employment, consumer, and tenancy rights since the early 20th century.<ref>e.g. EU [[National Labor Relations Act of 1935]] §1. EU [[Unfair Terms in Consumer Contracts Directive]].</ref> [[Thomas Piketty]] in ''[[Capital in the Twenty-First Century]]'' explains how unequal bargaining power undermines "conditions of "pure and perfect" competition" and leads to a persistently lower share of income for labor, and leads to growing inequality.<ref>T Piketty, ''[[Capital in the Twenty-First Century]]'' (2011) ch 9, ‘insofar as employers have more bargaining power than workers and the conditions of “pure and perfect” competition that one finds in the simplest economic models fail to be satisfied…’.</ref> While it was argued by [[Ronald Coase]] that bargaining power merely affects distribution of income, but not productive efficiency, the modern behavioural evidence establishes that distribution or fairness of exchance does affect motivation to work,<ref>A Cohn, E Fehr, B Herrmann and F Schneider, ‘Social Comparison in the Workplace: Evidence from a Field Experiment’ (2014) Journal of the European Economic Association</ref> and therefore unequal bargaining power is a market failure.<ref>Discussed in E McGaughey, ‘Behavioural Economics and Labour Law’ (2014) [https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2460685 LSE Law, Society and Economy Working Papers 20/2014], 12-13 in A Ludlow and A Blackham, New Frontiers in Empirical Labour Law Research (2015) ch 6</ref> Notably, the price of labour was excluded from the scope of the original charts on supply and demand by their inventor, [[Fleeming Jenkin]], who considered that the wages of labour could not be equated with ordinary markets for commodities such as corn, because of labour's unequal bargaining power.<ref>F Jenkin, 'The Graphic Representation of the Laws of Supply and Demand and Other Essays on Political Economy' (1887, 1996 edn Routledge)</ref>

===Bounded rationality===
{{main|Bounded rationality|Behavioral economics}}
In ''Models of Man'', [[Herbert A. Simon]] points out that most people are only partly [[Rationality|rational]], and are emotional/[[irrational]] in the remaining part of their actions. In another work, he states "boundedly rational agents experience limits in formulating and solving complex problems and in processing (receiving, storing, retrieving, transmitting) [[information]]" ([[Oliver E. Williamson|Williamson]], p.&nbsp;553, citing Simon). Simon describes a number of dimensions along which "classical" models of rationality can be made somewhat more realistic, while sticking within the vein of fairly rigorous formalization. These include:
* limiting what sorts of [[utility]] functions there might be.
* recognizing the costs of gathering and processing information.
* the possibility of having a "[[vector (geometry)|vector]]" or "multi-valued" utility function.

Simon suggests that economic agents employ the use of [[heuristics]] to make decisions rather than a strict rigid rule of optimization. They do this because of the complexity of the situation, and their inability to process and compute the expected utility of every alternative action. Deliberation costs might be high and there are often other, concurrent economic activities also requiring decisions.

The concept of bounded rationality was significantly expanded through behavioral economics research, suggesting that people are systematically irrational in day to day decisions. [[Daniel Kahneman]] in ''[[Thinking, Fast and Slow]]'' explored how human beings operate as if they have two systems of thinking: a fast "system 1" mode of thought for snap, everyday decisions which applies rules of thumb but is frequently mistaken; and a slow "system 2" mode of thought that is careful and deliberative, but not as often used in making ordinary decisions to buy and sell or do business. 

===Macro-economic failures===
{{main|Unemployment|Inflation|Macroeconomics}}
"Unemployment, inflation and "disequilibrium" are considered a category of market failure at a "macro economic" or "whole economy" level.<ref>J Stiglitz and J Rosengard, ''The Economics of the Public Sector'' (2015) ch 4, 93</ref> These symptoms (of high job loss, or fast rising prices or both) can result from a financial crash, a recession or depression, and the market failure is evident in the sustained underproduction of an economy, or a tendency not to recover immediately. Macroeconomic [[business cycle]]s are a part of the market. They are characterized by constant downswings and upswings which influence economic activity. Therefore, this situation requires some kind of government intervention.<ref name=":0" />

===Persistent labor shortages===
{{main|Shortage#Labour shortage||}}

Widespread and persistent domestic labour shortages in various countries are examples of market failure, whereby excessively low [[Salary|salaries]] (relative to the domestic [[cost of living]]) and adverse [[Occupational stress#Causes of occupational stress|working conditions]] (excessive [[workload]] and [[Working time|working hours]]) in low-wage industries ([[Hospitality industry|hospitality and leisure]], [[Educational stage|education]], [[health care]], [[Rail transport|rail transportation]], [[Warehouse|warehousing]], [[aviation]], [[retail]], [[manufacturing]], [[Food industry|food]], [[construction]], [[elderly care]]), collectively lead to [[occupational burnout]] and attrition of existing workers, insufficient [[Incentive|incentives]] to attract the inflow supply of domestic workers, short-staffing and regular [[shift work]] at [[Workplace|workplaces]] and further exacerbation ([[positive feedback]]) of staff shortages. Poor job quality and artificial shortages perpetuated by salary-paying employers, deter workers from entering or remaining in these roles.

Labour shortages occur broadly across multiple industries within a rapidly expanding economy, whilst labour shortages often occur within specific industries (which generally offer low salaries) even during economic periods of high unemployment. In response to domestic labour shortages, business associations such as [[Chamber of commerce|chambers of commerce]], [[Trade association|trade associations]] or [[Employers' organization|employers' organizations]] would generally lobby to governments for an increase of the inward [[immigration]] of [[Foreign worker|foreign workers]] from countries which are [[Developing country|less developed]] and have lower salaries. In addition, business associations have campaigned for greater state provision of [[child care]], which would enable more women to re-enter the labour workforce at a lower wage rate to achieve [[economic equilibrium]]. However, as labour shortages in the relevant low-wage industries are often widespread globally throughout many countries in the world, immigration would only partially address the chronic labour shortages in the relevant low-wage industries in [[Developed country|developed countries]] (whilst simultaneously discouraging local labour from entering the relevant industries) and in turn cause greater labour shortages in developing countries.