Market power sometimes lead to misallocation of resources. What should the govt. do when market failure occur?
Under market economy, capitalist or private entrepreneurs control the economic activities. They organise and undertake production with the sole motive of profit making. Now, since the sole motive of private producers is to earn profits, it may lead to misallocation of resources in ways which are not beneficial for the society as a whole. Such a situation is referred as market failure. Government can take the following steps in a situation of market failure.
1) Buffer stocks - Government can keep the buffer stock of basic necessities of the economy to use it to stabilise prices in a situation of market failure.
Buffer stock aims to stabilise prices, ensure supply of necessities and to prevent producers from leaving the market when the price of their product drops.
2) Laws and Regulation - Government may impose various legal and regulatory restrictions to regulate demerit goods like ban on cigarette consumption at public places etc to avoid misallocation of resources used in producing cigarettes.
3) Tax on emissions- Government can impose taxes on emissions of harmful gases such as carbon monoxide, carbon dioxide to reduce misallocation of resources on goods with high social cost.
1) Buffer stocks - Government can keep the buffer stock of basic necessities of the economy to use it to stabilise prices in a situation of market failure.
Buffer stock aims to stabilise prices, ensure supply of necessities and to prevent producers from leaving the market when the price of their product drops.
2) Laws and Regulation - Government may impose various legal and regulatory restrictions to regulate demerit goods like ban on cigarette consumption at public places etc to avoid misallocation of resources used in producing cigarettes.
3) Tax on emissions- Government can impose taxes on emissions of harmful gases such as carbon monoxide, carbon dioxide to reduce misallocation of resources on goods with high social cost.