A MARKET is a shorthand expression for the process by which households' decisions about consumption of alternative goods, firms' decisions about what and how to produce, and workers' decisions about how much and for whom to work are all reconciled by adjustment of PRICES.
This is to create what is called the 'Pareto optimum' or...
Pareto-efficient (optimum) for a given setof consumer tastes, resources and technology, if it is impossible to move to another allocation which would make the person worse off.(Vilfredo Pareto 1909)
Basically the 'best possible arrangement',
For society in general all this mumbo jumbo with markets is at its best or most efficient when MARGINAL BENEFITS (MB) are equal to MARGINAL COSTS (MC), you then achieve...
Markets and Social Efficiency!!
Yet...
If there are external costs and benefits present in the process, unregulated markets will not produce the socially efficient level of output, then you achieve...
MARKET FAILURE!!
Which is a very over-dramatic phrase for describing all circumstances(distortions) in which equilibrium in free unregulated markets will fail to achieve efficient allocation of resources.
So we get to the causes of these,
Public Goods
These goods will not be supplied by private markets, so require public provision, (the NHS)
External Costs and Benefits (Externalities)
A common trait at the root of all environmental problems is the failure of markets to reflect ALL the costs and benefits associated with the environment.
Social cost = private cost + external costs (same for benefits)
EXTERNALITY
Arise whenever an individual's (or companies) production or consumption decision has a direct impact on the production or consumption of another individual, (without acceptance)for example...pollution costs or the benefit arising from a farmer maintaining a hedge,
The main features of an Externality;
- The affected party can not choose the level of impact,
- It does not refer to deliberate attempts of another individual to influence another,
- It is an example of market failures,
- Two types of externalities, costs and benefits, production and consumption,
Companies can 'internalise' an Externality,
In conclusion, governments are really needs to intervene to reduce external costs, and enhance the benefits,
- Individuals and firms respond to incentives, they act to maximize profits (benefits) markets fail to create incentives for individuals to take account of the full implication of their actions, leading to environmental damage,
Policy mechanisms are aimed to improve these incentives!
