To correct market failure, economists suggests the following.
- Control of Monopoly Power
Monopoly power can be controlled by the government by anti-monopoly laws and restrictive trade practices legislation. These aim at removing unfair competition, preventing unfair price discrimination and fixing prices equal to competitive prices.
The government can also bring down monopoly price to competitive level by price regulation and taxation. It may impose price ceiling so that monopoly price should be near or equal to competitive price. This can be done by appointing a regulating authority of commission which fixes a pie for the monopoly product below the monopoly price.
Taxation is another way to control monopoly power. The tax may be levied lump sum without any regard to the output of the monopolist. Or it may be proportional to the output, the amount of tax rising with the increase in output. In either case, the aim is to bring monopoly price to the competitive level. Lastly, Prof. Pigou favoured nationalisation of monopoly to put an end to monopoly power.
To achieve optimal allocation of resources in the face of externalities, Pigou suggested social control measures and the use of taxes and subsidies. The state can interfere in all cases of external diseconomies of production to remove the divergence between private and social costs and benefits. For instance, it can ask the factory owner to move out of the residential area by providing appropriate facilities to the smoke emitting factory. In the case of external diseconomies of consumption, the state can put an end to noise nuisance by banning the use of loud speakers except for special occasions during specific hours with prior permission
Pigou further suggested that the state should encourage production of goods wit positive externalities by the grant of subsidy on per unit of commodity to the producer. It can help consumers in maximising their satisfactions by tax concessions so that they consumer more commodities. In the case of negative externalities it should discourage their consumption and production by levying taxes.
For instance, the state can levy a tax on every family in the area and pay the sum so collected to the smoke emitting factory to move away. Thus taxes and subsidies help to bridge the gap between private and social costs and benefits.
Another measure commonly suggested is internalisation, or unitisation or externalities in production. For example, firms that are engaged in oil operations in the same field lead to inefficient over drilling and over pumping. With unitisation or merger of firms oil is produced most efficiently without diseconomies of production.
- Public Goods
Since public goods are non-excludable and non-rivalled, they are not sold in a free market like private goods. Hence, they cannot be provided by private firms. In this situation, they can be provided by some public authority. As the benefits of public goods are indivisible, the state should make people share the costs of public goods so that every one is made better off.
“One way to pay for a public good is to charge each person the same proportion of the maximum amount he or she would be prepared to pay rather than go without the good, while fixing that proportion so as to cover the total costs of production.
” In the case of some public goods such as materials for defence the government can either itself produce them or it can pay private firms to produce them. So fare as the ‘free rider problem’ is concerned whereby such services as defence, police etc are provided free to every user, they can be provided by the government out of tax revenue.
- Increasing Returns to Scale
For the problem of increasing returns to scale, opinions differ concerning government’s role in providing solution to market failure. Some economists opine that government should nationalise such industries which operate under decreasing cost and lead to over production. Others do not approve of it for the reason that they feel that government control would make conditions worse. Still others suggest that private firms should produce goods and government should enforce price regulation and tax them so that social and private costs and benefits are equalised.
The solution to the problem of indivisibility in the case of goods and services used jointly by more than one person such as street lighting or road, the local body such as Municipal Corporation should either spend on its repairs and maintenance or tax the residents or users of the road or street lighting.
- Property Rights and the Coase Theorem
Common property rights lead to externalities. Property rights relate to “who owns property, to what uses it can be put, the rights people have over it and how it may be transferred.” One solution is to extend property rights so completely that every one has the right to prevent people from imposing any costs on them. This can be done in the case of public property like parks, libraries etc.
The second solution is to distribute the property of the rich to the poor. But it is more a question of altering property rights rather than extending the ownership rights. But such a solution will be impractical.
The third solution is for the government to charge the damages and compensate for the damages. But it involves the problem of compensating those who acquired property at a lower cost for the reason that the damage.
The fourth solution is to file a legal suit for monetary damages by the party that has been harmed by the externality. Another solution has been suggested by Prof. Ronald Coase, according to him, market failure due to property due to property rights can be eliminated through private bargaining among the affected parties.
He points out that if property rights are clearly defined and marketable and transaction costs are zero, a perfectly competitive economy will allocate resources optimally, even under externalities. This is called Coase Theorem.
- Missing Markets
To correct market failure in the case of missing or incomplete markets where two commodities are jointly produced, two Nobel Laureates K Arrow and G Debreu suggest a separate market for each in which each good and service can be traded to the point where the social and private marginal benefit equals the social and private marginal cost. This will lead to optimal allocation of resources.
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