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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 -