Download 5) Where needed markets do not exist

Understanding business behavior
B200 - TMA 02
TMA 02
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
Market function and its
cause's failure
Introduction
Marketing is the term given to those activities that occur at the
interface between the organization and its customers. It comes from the
original concept of a marketplace, where buyers and sellers would come
together to conduct exchanges for their mutual benefit. The aim of
marketing as a discipline is to ensure that customers will conduct
exchanges with the marketer's organization, rather than with the other
'stallholders'.
Marketing is the management process which identifies,
anticipates, and supplies customer requirements efficiently and
profitably. It is the process of planning and executing the conception,
pricing, promotion and distribution of ideas, goods and services to create
exchange and satisfy individual and organizational objectives.
The function of a market requires, at a minimum, that both
parties expect to become better off as a result of the transaction.
Marketing role is contained within marketing department that
carries out the communications functions of the firm.
Market failure is a term used by economists to describe the
condition where the allocation of goods and services by a market is not
efficient.
The function of a market requires, at a minimum, that both
parties expect to become better off as a result of the transaction.
Markets generally rely on price adjustments to provide information to
parties engaging in a transaction, so that each may accurately gauge the
subsequent change of their welfare. In less sophisticated markets, such
as those involving barter, individual buyers and sellers must engage in a
more lengthy process of haggling in order to gain the same information.
Markets are efficient when the price of a good or service attracts
exactly as much demand as the market can currently supply.
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
The chief function of a market, then, is to adjust prices to
accommodate fluctuations in supply and demand in order to achieve
allocative efficiency.
An economic system in which goods and services are exchanged
by the mean of markets (i.e. the decision of exchange regarding the
prices and the quantity are decentralized - taken by the agents involved
in the exchange themselves) is called a market economy. An alternative
economic system in which non-participants to the exchange (often
government mandates) determine prices are called planned economies or
command economies. The attempt to combine socialist ideals with the
incentive system of a market is known as market socialism.
A fundamental aspect of an economy or market is competitions.
Firms compete against each other to offer goods. For a market to have
competition, it must meet several conditions: buyers and sellers both
take the market price as given, there are a large number of competing
companies, there is nothing to keep more companies from entering the
market, all firms produce the exact same products, firms can come and
go immediately with no delay whatsoever, everyone would have
instantaneous and complete information about all firms, all firms have
make profit as their one and only goal.
Even though markets do not exist, they are useful to analyze real
markets because putting in many other factors is compounding the
problem at this point. Competitive firms have supply curves, first of all.
Because of the fact that they themselves must actually adjust to
changing market situations. A firm with no competition can set whatever
prices they want since people have to buy their products anyway. The
market as a whole has a demand curve, but each individual firm's demand
curve is perfectly horizontal: no matter how they change the production,
price stays. Remember, firms are price takers, too in perfect
competitions, they don't set prices.
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
1- Schumpeter model (innovation, dynamism):
 Innovation in new products and new process. Ex; (computer).
 Innovation new products using new process of production.
 Capitalism a form or method of economic change and not only never is
but never can be stationary
Schumpeter outlines his view of the evolutionary nature of capitalism
where firms are forced to innovate in order to stay in the race. These
firms which do not do this, or which fall behind in the race to innovate,
will go out of business. Schumpeter refers to this competitive process of
"innovate or go bust" as one of "creative destruction". This view of
competitive markets as a dynamic process of continuous change. The key
to this process is the introduction of innovations, new products and new
processes like motor car.
2-Neo Classical or the perfect competition (price and equilibrium)
 Neoclassical model of competitive equilibrium or perfect competition
in determination of the price. According to this model of competition,
prices are determined impersonally in the market, and this secure
equality between these demanding the good and those supplying the
good.

The strength of the neoclassical model is that it shows the equilibrium
properties of a competitive market.
3- Hayek's model (price, process of change, and information)
A conservative and “libertarian”:
He believes in liberty of individuals first and in other social goals second.
COMPETITIVE MARKETS AND INFORMATION
Price as signals



One economist F.A Hayek said that individuals never have complete
information when responding to economies changes.
Hayek sees changing competitive prices as signal mechanism for
transmitting information between individuals in the market.
By responding to these changes prices, producers and consumers are
led to respond in an appropriate way to economic changes.
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02



Hayek emphasizes the importance of the process of competition
rather than the end result of equilibrium.
Information about changes in consumers tastes or in the conditions of
production, is transmitted by changes in prices
In this competitive process Hayek emphasizes the importance of price
system as a decentralized mechanism for transmitting information
prices are information signals.
4-Sen's model (Conflict, Power imbalance, and Inequality): power
balance
 Sen’s approach argues that the neoclassical emphasis is on balance and
harmony of interest obscures the conflicts of interest in market
transaction.
 Sen is saying that the balance is of powers and muscles.
Market types:
 Monopolies - one firm in market
 Oligopoly - a few firms in the market
 Competitive Market - many firms in the
market
 Natural Monopolies - high costs to build
infrastructure, and high cost of
maintenance, can be privatized
successfully, must be regulated to an
extent (electricity, water supply,
railroads, telecommunications)
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
The table below to summarize the main factors to differentiate
among the four types of competition models:
Schumpeter's
Model
Model of
competition
Organizations
Source of
efficiency
Freedom
Neoclassical
Model
Hayek's
model
Sen's
model
Dynamic competition
forward-looking
competition over
innovations in products and
processes
Perfect
competition/
competitive
equilibrium,
Equilibrium
Price where
demand=supply
Competition as a
process of
adjustment to
change; prices
are signals which
transmit
information
Dynamic efficiencyinnovations arising from
technological advances and
economies of scale result in
lower prices and costs
Productive
efficiencyprices and costs
at the minimum
level given
existing
technology
The
decentralized
price mechanism
transmits
information
about changing
preferences and
conditions of
production
Competition as
a power
struggle
markets
characterized
by conflict
rather than by
harmony of
interests
Emphasis here
not on
efficiency
whose gains
may occur to
all, but on the
unequal nature
of the gains
and losses
Large corporations with
their entrepreneurial
managers
Firms are pricetakers
Firms respond to
price signals in
an environment
where they
cannot have all
the information
Economic
organizations
are part of
the struggle
for economic
power
Price system
guarantees
individual
freedom; market
outcomes are
neither just nor
unjust; freedom
as negative
freedom
Emphasis on
freedom as
enabling
powers and
capabilities
(positive
freedom), but
markets do
not ensure
this for all
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
Market failure is a term used by economists to describe the
condition where the allocation of goods and services by a market is not
efficient. It occurs when freely-functioning markets, operating without
government intervention, fail to deliver an efficient or optimal allocation
of resources.
There are two Sources of market failure
 Monopolies lead to higher prices, lower quality, less competition,
less innovation, less development in the economy, more inequality,
less transfer of knowledge and technology
 Externalities - the market does not account for costs and benefits
to the larger society. Sometimes known as the neighborhood
effect or the third party effect.
 Monopoly
Few modern markets meet the stringent conditions required for a
perfectly competitive market. The existence of monopoly power is often
thought to create the potential for market failure and a need for
intervention to correct for some of the welfare consequences of
monopoly power.
They are the side effects borne by third parties. In each case
the firms or the individuals will bear some form of cost known as the
external cost. There are a number of types of externality. Some are of
particular relevance to the copper industry.
In monopoly, the market does not account for costs and benefits
to the larger society. Sometimes known as the neighborhood effect or
the third party effect.
 Externalities
Any exam question on market failure must make some reference
to externalities. What are the potential market failures arising from
externalities?
The social optimum output or level of consumption diverges from
the private optimum.
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
Main problem is the absence of clearly defined property rights
for those agents operating in the market. When property rights are not
clearly defined, market failure is likely because producers & consumers
may not be held to account
An externality is a spill over from an economic activity. It is
often referred to as a by-product of the market mechanism (supply
equals demand). Negative externalities are often viewed as examples of
market failure, in other words, the market mechanism creates a level of
consumption / production that is higher than society desires.
Externalities are where the consumption or production of a good
impacts on people other than the producers or consumers that are
participating in the market for that good.
Externalities are costs or benefits of transaction that are
incurred or received by other members of the society but not taken into
account by the parties to the transaction.
A negative externality occurs when the by-product is viewed as
having a social cost. For instance, when a car is driven it creates air
pollution.
This implies that a negative externality occurs when the social cost is
greater than the private cost. If the two values where the same, then
there would not be a negative externality.
Negative externalities can be created through either the consumption or
production of a good.
A consumption created negative externality is illustrated below;
Don't forget that positive externalities can also justify
intervention if goods are under-consumed (social benefit > private
benefit). In addition to negative externalities there are positive
externalities i.e. benefits accruing to non-participants in the market
place arising from the consumption and production of goods and services.
These are the external benefits.
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
This Mind Maps have been produced to introduce topics and give
an overview of externalities types
There are several important circumstances under which
markets fail to allocate resources with reasonable efficiencies:






1) If there are resources that can be used by everyone but belong to
no one- common property resources.
2) If there are goods whose consumption cannot be restricted to those
who are willing to pay for them. Public goods.
3) If people not party to some market bargain are none the less
significantly affected by it – externalities.
4) If one party to a market transaction has fuller knowledge of its
consequences than is available to other party – asymmetric information.
5) Where needed markets do not exist
6) Where substantial monopoly power exist.
When Markets Fail
Non rivalries and non excludable goods:
 Rivalries: if no 2 persons can consume the same unit. An example is the
international example; in Apple comp.
 Excludable: if people can be prevented from obtaining it. Owner of a
good give it to who pay for it.
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
Example
The common examples of market failure include environmental
problems such as pollution or overexploitation of natural resources.
Nevertheless, some economists see these as symptoms of public property
rather than free markets.
======================================
Conclusion
Finally, Market failure can be viewed as a scenario in which
individuals' pursuit of self-interest leads to bad results for society as a
whole. The belief that markets can fail is a common mainstream
justification for government intervention in free markets. However, not
all economists believe that market failures occur, or that they are
compelling arguments for government intervention, due to government
failure.
Shaima Uthman AL-Morsy – www.aoua.com -
Understanding business behavior
B200 - TMA 02
References:





B202 course material, market model.
http://www.bized.co.uk
http://www.tutor2u.net/economics/content/topics/marketfail/market
_failure.htm
http://en.wikipedia.org/wiki/Market_failure#Causes
B300 course material.
Shaima Uthman AL-Morsy – www.aoua.com -