Market power, equity, and government failure
Markets can be inefficient because of market power, and even efficient markets can produce outcomes many consider unfair. Government action has its own failures too.
Market power as market failure
When firms have market power, they restrict output and charge prices above marginal cost, creating deadweight loss. Remedies include antitrust enforcement, blocking anti-competitive mergers, regulating natural monopolies, and lowering barriers to entry.
Efficiency versus equity
Efficiency is about maximising total surplus; equity is about how fairly it is shared. A competitive market can be efficient while leaving some people very poor. Economics can describe trade-offs, but deciding what is fair involves value judgements.
Measuring inequality
The Lorenz curve plots the cumulative share of income received by the poorest x% of households. The Gini coefficient measures how far it falls below perfect equality: 0 means everyone has the same income, 1 means one person has everything. Wealthy countries' income Gini coefficients typically range from about 0.25 to 0.40 after taxes and transfers.
Redistribution
Governments redistribute through progressive taxes (higher rates on higher incomes), transfers such as unemployment benefits and pensions, and public services like education and healthcare. Redistribution can reduce poverty but may weaken work incentives somewhat; how much is debated and depends on design.
Merit and demerit goods
Merit goods, such as education and vaccination, are thought to be underconsumed if left to the market, often because people undervalue long-term benefits or because they have external benefits. Demerit goods, such as tobacco, are thought to be overconsumed. Governments subsidise or mandate the first and tax or restrict the second.
Government failure
Government intervention can also make outcomes worse. Causes include poor information, unintended consequences, lobbying by special interests (rent-seeking), short-term electoral incentives, and bureaucratic inefficiency. Public choice economists, such as James Buchanan, analyse politicians and officials as self-interested actors.
Choosing policies
Good policy compares the imperfect market with imperfect government action. Tools include cost-benefit analysis, pilot programmes and randomised trials, sunset clauses that make policies expire unless renewed, and designs that harness incentives rather than fighting them.
Worked example
A city caps taxi licences to keep fares stable. Over decades, licence prices soar because limited supply creates monopoly profits, and existing licence owners lobby to keep the cap. Ride-hailing apps later reveal the unmet demand. The cap, intended to protect consumers, became a source of rent-seeking: a government failure.
Key takeaways
Market power causes deadweight loss and is addressed by antitrust and regulation. Efficiency and equity are distinct; fairness involves values. The Lorenz curve and Gini coefficient measure inequality. Redistribution reduces poverty with some incentive costs. Merit and demerit goods justify subsidies and taxes. Government failure means intervention must be designed and evaluated carefully.
Flashcard
Ability to raise price above MC
Check your understanding
A Gini coefficient of 0 means: