Market failure refers to a situation where the economy suffers from an inefficient distribution of commodities. In the face of such failure, the government may use various interventions to restore the market to its full production capacity ( Marciano & Medema, 2015) . An example of such interventions commonly used by the government to control the market is the fiscal policy. However, an excess of government expenditures in the economy is highly likely to endanger the economy by further worsen the related consequences of market failure. Government failure is, therefore, a situation where government intervention programs meant to salvage the economy only ends up creating inefficiency in the market.
Market Failure and Government Failure
Examples of Market Failure
The common types of market failures are monopoly (market power), externalities, information asymmetry, and public goods (missing markets) ( Marciano & Medema, 2015) . Externalities can be positive or negative and refer to a situation in the market where some costs or benefits created by consumers and producers cause a “spill-over” effect to third parties. Third-parties are individuals or entities that indirectly benefit or suffer as a result of trade transactions conducted by consumers and producers to achieve their self-interest. An example of a negative externality is pollution that results from the production of goods by a factory. Community members leaving around the factory get exposure to the harmful health effects that might arise from the pollution. Externalities such as pollution contribute to market failure because the price of a good or service associated with it does not reflect the benefits or costs associated with producing such goods ( Schiller, 2017) .
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Information asymmetry is also another form of market failure. It occurs when the market lacks transparency and the free flow of information. Information asymmetry, therefore, provides an opportunity for exploitation for buyers in the market. For example, buyers paying a higher price for a commodity which would not have been possible if they had access to information about defects or functionality of the item. The existence of monopolies is also another market failure. It occurs when a single producer controls market power. Monopolies limit competition by making it hard for other firms to gain footing in the market ( Schiller, 2017) . The existence of public goods creates market failure because their consumption cannot be restricted whether a party pays or does not pay for it.
Examples of Government Failure
Examples of government failure include regulatory capture, crowding out effect, unintended consequences, imperfect knowledge, and distortion of the price mechanism. Regulatory capture occurs when members of government agencies become friendly attached to the businesses they are regulating ( Mihalache & Bodislav, 2019) . Such friendship leads to rational ignorance, which causes regulatory risk. Crowding out effect, on the other hand, occurs when the government displaces private sector investment by way of higher interest rate or expands tax cuts above revenue.
Distortion of price mechanism occurs from interventions such as taxation or subsidization on goods and services. Such interventions can lower or raise prices in the market ( Mihalache & Bodislav, 2019) . Imperfect knowledge results from information failure on the part of the government. Policymaker, at times, lacks information and technical know-how to enable them to make effective decisions and allocate scarce resources in the market. Failures resulting from unintended consequences arise when the government enacts beneficial policies that, in turn, create spill-over effects on the market. For instance, adopting policies to reduce poverty can create ‘welfare dependency’ which can end up creating problems such as lower levels of labor market participation.
Challenges Faced by Economies in Light of Optimal Allocation and Public Goods
Optimal allocation of resources can directly contribute to the crowding-out effect in the economy, which has negative consequences on the prices of products in a free-market system. Even though optimum production will be enhanced, the government may need to expand its borrowing to ensure that resources are optimally allocated. Interest rates will increase in the process, thereby displacing private sector investment ( Kamei, Putterman, & Tyran, 2015) . Also, the government will be in a position to fix prices, which can create distortions like shortages and surpluses in the economy. Surpluses result when prices are above the natural market rate. There will be an overproduction of commodities in the market because supply will exceed demand, which distorts market equilibrium.
Some of the challenges faced by economies in light of public goods include underproduction. The provision of public goods breaks the link between payment and consumption. Therefore, people will always be reluctant to buy goods because they can get them for free ( Schiller, 2017) . Public goods, therefore, present a dilemma because the demand is always hidden because of free-ride associated with the goods. The market will tend to under-produce public goods while overproducing private goods. The exclusion of non-payers of public goods is often difficult because it is costly and impractical because of the ‘free-rider” problem ( Kamei, Putterman, & Tyran, 2015) .
References
Kamei, K., Putterman, L., & Tyran, J. R. (2015). State or nature? Endogenous formal versus informal sanctions in the voluntary provision of public goods. Experimental Economics , 18 (1), 38-65.
Marciano, A., & Medema, S. G. (2015). Market failure in context: introduction.
Mihalache, R. P., & Bodislav, D. A. (2019). Government failure vs. Market failure. The implications of incomplete information. Theoretical & Applied Economics , 2 (2).
Schiller, R., Bradley. (2017). Hostnezt.com. Retrieved 29 February 2020, from https://hostnezt.com/cssfiles/economics/Essentials%20of%20Economics%20By%20Bradley%20R%20Schiller%2010th%20Edition.pdf .
