Rationales for Public Policy: Marke

Rationales for Public Policy: Market Failures

Chapter 5 begins with the basic economic premise that the “idealized competitive model produces a Pareto-efficient allocation of goods.” In other words, the utility-maximizing behavior of people and the profit-maximizing behavior of firms will distribute goods in a way that no one could be better off without making anyone else worse off. This is referred to as the “invisible hand” by economists. However, the real world doesn’t operate as neatly as a simple economic equation. Deviations from this model and their underlying assumptions constitute market failures. Traditional market failures are “shown as circumstances in which social surplus is larger under some alternative allocation to that resulting under the market equilibrium.” The four common market failures are: public goods, externalities, natural monopolies, and information asymmetries. It is because of such failures that rationale exists for intervention (usually from the government) in otherwise private affairs.