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General Equilibrium and the Efficiency...
The Sources of Market Failure

Market failure occurs when resources are misallocated, or allocated inefficiently. There are four important sources of market failure, each of which results from the failure of one of the assumptions basic to the perfectly competitive model. Each also points to a potential role for government in the economy.

Imperfect Markets

The first type of market failure is called imperfect competition. An imperfectly competitive market is one where the assumption of many buyers and sellers does not hold. These types of market organizations include monopoly, monopsony, oligopoly, and monopolistic competition.

A monopoly is a market with one seller and many buyers. A monopoly may exist because of special government regulation or because the monopolist is the sole owner of a resource (due to a patent or some other reason). Airlines are a classic example of an oligopolistic industry, one that is dominated by a few large firms.

Monopolistic competition is a market organization where large numbers of monopolists each make a unique product, but all products are substitutes. An example is local pizza stores. They each make a unique pizza, but when it comes right down to it, eating at one store is not all that different from eating at another store.

None of these markets are efficient. In general, the firms do not produce the socially optimal quantities (they tend to under-produce) and the price is higher than it would be under perfect competition. The condition P = MC does not hold, and the system does not produce the most efficient product mix.



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