Market failures involve the decentralization of behavior that does not result in Pareto efficiency. Traditionally, market failures are said to be circumstances where a social surplus is enlarged under some form of alternative allocations that result from market equilibrium. The commonly recognized market failures are natural monopolies, externalities, information asymmetry, and public goods. These market failures provide traditional economic rationales for the public to participate (Cowen, 2002). Market failures have an influence on the approaches taken towards the design and scope of policy analysis. This paper will look at these approaches and scope of policy analysis as influenced by market failure. It will also look at how the interplay between market failures and the public response affects the particular approach taken.
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The rationale for public policy
Market failures lead to rationales, which can influence the design and scope of policy analysis. The rationale behind public policy in a competitive model that is idealized leads to the production of a Pareto efficient goods allocation process. This means that the behavior of maximizing profits by organizations, as well as people’s behavior of maximizing utility through an invisible hand leads to the distribution of goods. This is in such a way that none of the parties will be at a greater advantage than the other. Pareto efficiency comes about as a result of voluntary actions that do not need any public policies. There are, however, some violations in an ideal competitive market. These violations are what lead to market failures (Weiner & Vining, 2005). A clear understanding of the rationale behind the competition model helps in designing policies and determining the scope of the policy analysis process to prevent any further market failures in the future.
Public goods are a common term when it comes to economics and policy analysis. Market failure results from inefficient allocation of public goods. This can be understood by contrasting public and private goods. If this is clearly understood, then an organization can create policies that prevent market failures (Zagler, 2009).
Natural monopolies come into existence when a supplier has a big cost advantage over some of its competitors. The rationale behind the existence of natural monopolies should be clearly understood. This understanding will act as a guide for a company that is a natural monopoly when it comes to its production process. With a good public policy analysis, the natural monopoly will survive in the market.
Externalities affect a party that is not involved in a transaction directly. Therefore, understanding the rationale behind public policy can lead to the design of a policy analysis process that will focus on the particular externalities that have an impact on the particular business. This analysis will minimize any effects of externalities that are likely to result in market failures (Weiner & Vining, 2005)
Information asymmetries lead to market failures when a producer is not able to supply sufficient information that maximizes the difference between the underestimation of consumers and the overestimation of good quality. Public policy analysis is, in this case, important in ensuring that this does not result in market failure (Weiner & Vining, 2005).
The interplay between market failure and public response
The public response and market failure both affect the approach that is taken during policy analysis. The public responds in a particular way towards business operations. This response can be used as a guide by the organization to analyze their policies in a way that ensures that all public needs are met. As discussed above, market failures form the basis for analyzing organizations’ policies. An interplay between the two leads to a more efficient policy analysis process (Zagler, 2009).
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It is important for any organization to clearly understand its potential failures in the market. Organizations should also put into consideration the response they get from the public and use that response to make changes that promote efficiency and the public good. Both market failures and public responses are workable means of steering organizations forward in terms of the policies they put in place.
Cowen, T. (2002). Public goods and market failures: a critical examination. New Brunswick: Transaction Publishers.
Weiner, D., & Vining, A. (2005). Policy Analysis: Concepts and Practices. (5th Ed). NY: Pearson Pub.
Zagler, M. (2009). Endogenous growth, market failures and economic policy. New York, N.Y.: St. Martin’s Press.