Free Market Is the Most Efficient Essay Example

be profit motivated and resources owners would want to maximise return on resources.

Thus they rely on the price mechanism to allocate resources. The free market which uses the price mechanism may appear to be the most efficient way of allocating resources.

As Allocative efficiency is achieved when the right amount of the right kind of goods is produced. Thus to achieve Allocative efficiency there must be a 'right product mix' which will then maximise the welfare of society. For private individual household and firms, when Marginal Private Benefit (MPB which is equal to Price [P])= Marginal Private Cost (MPC), i. P=MC, Allocative efficiency is achieved. With regards to society, when Marginal Social Benefit MSB) is equal to Marginal Social Cost (MSC), Allocative efficiency is achieved. At this output level, societys welfare is maximised.

Assuming there is the absence of externalities; Price (Demand) reflects both the marginal private benefit as well as the marginal social benefit. Similarly, the Marginal Cost (Supply) reflects both the marginal private cost and the marginal social cost. From Diagram 1, If the output of good A is at OQI, where P>MC (Also MSB>MSC).

This suggests that society values additional units of Good A more than the alternative goods that the resources are currently used tor.

Hence there is an under-allocation of resources to the production of good A. Consumer surplus of area ABEe is lost. Output of good A should be increased by reallocating some resources away from other industries to produce more of good A as to improve Allocative efficiency in the society. Conversely, if the output of good A is being produced at OQ2, of where P<MC (also

MSC<MSB), this suggests that society values additional units of good A less than what it is currently being used for.

Thus there is an over- allocation of resources to the production of good A, hence the production of Good A hould be decreased. Hence at the market equilibrium, OQe, P=MC and they are also equal to MSB=MSC.

Consumer and producers' surpluses are maximised and the market equilibrium output coincides with the socially optimum output of the industry. Thus through the price mechanism, the free market is the most efficient way to allocate resources. However, this may not always be the case as there are some types of goods/services, which the price mechanism fails to allocate resources efficiently; hence it results in market failure.

Market failure refers to a situation when the price mechanism fails to allocate esources efficiently. There are two forms of market failure.

The first form: total market failure, this refers to a situation where there is a total collapse of the price mechanism due to the missing demand curve. The second form is called partial market failure, which refers to a situation where the price mechanism is unable to allocate resources efficiently resulting in overproduction (in the case of Demerit goods) or underproduction (as in the case of merit goods). There is a situation where there is total market failure.

The collapse of the price mechanism is due to the missing demand curve. This occurs in the case of public goods.

A pure public good has features of non-excludability, which means it is not economically feasible to exclude anyone from using the good once it is provided and non-rivalry in consumption which

refers to the situation where the consumption of the good/service by a individuals does not diminish another person's ability to consume the same good/service. The property of non-excludability give rise to the problem of 'free rider-ship' where it is possible for a person to consume a public good without having to pay for it.

From the demand side of the market, the desire to e a free rider weakens the incentive for consumers to offer to pay for public goods. Hence it is impossible to charge a market price for a public good. If such goods, For example, Street lamps, were to be left to the free market (private enterprise) they would not be provided at all. Moreover the feature of non-rivalry also means the opportunity cost or MC of producing one more of the good is Zero.

Since MC is zero for a public good, at socially optimum output which occurs when P (MSB) = MC (MPC), the socially ideal price will be zero market price.

Therefore at zero market price, zero mount will be supplied to the market since producers in the free market are assumed to be profit motivated. Hence, because of the characteristics and nature of public goods, this results in complete market failure as no resources are allocated to these goods that are beneficial and essential to the society. i. e resources not allocated efficiently.

In addition to the tactors that contribute to market tailure, partial market tailure refers to cases that largely derived from market imperfection. A factor that contributed to partial market failure is market dominance.

In this essay I will use the xample of monopoly to illustrate

market failure from market dominance as monopoly is assumed to have high market dominance due to the high empirical evidence in the real world that monopoly holds the most market share. Misallocation of resources may result due to the increased market power of the firm which can possibly lead to consumer exploitation. Allocative efficiency is achieved and consumers' welfare is maximised when the firm produces where P=MC.

However, As Monopolies is assumed to have profit maximisation as their main objective.