ECONOMICS

Essentials of Economics

Essentials of Economics

Introduction

This paper is divided in three sections, where the first section explains the concept of market failure. It discusses that how market failure occurs under the scenarios such as, Imperfect Competition, Externalities, Public Goods and Merit goods. In addition, the second section discusses the usefulness of the Production Possibility Curve as a theoretical tool in the study of economics. Moreover, with the assistance of demand and supply diagrams, the effects of the markets are explained for Scottish bottled water.

Discussion

Market Failure

Economic theory establishes that in a free and unfettered market, characterized by intense competition between many well-informed buyers and sellers, where resource mobility is possible, a socially efficient allocation of an economy's resources is generated. Characteristic of perfectly competitive markets, this social efficiency is measured as the maximization of total market surplus that is, the sum of consumers' and producers' surpluses are maximized at a market-determined equilibrium price (elmo.shore.ctc.edu). For the individual firm, the consequence of this intensely competitive market is that price for the seller is determined within the market, and the only profit-maximizing mechanism available to the firm is to set production levels such that profits are maximized. This occurs when the firm's marginal cost of production equals the market price. Any deviation from this price will generate a reduction in market surplus, commonly referred to as a deadweight loss. When a deadweight loss occurs, a market failure is said to result (www.colorado.edu).

Imperfect Competition

Monopoly

Monopoly is said to exist when there is only one firm or supplier of any particular product or service, thus that firm demands a high price as there is no competition. In the economic sphere, monopoly generally has a negative implication. Under competitive conditions with many buyers and sellers, prices are bid down to the cost of production and, in the absence of externalities, such as pollution, this yields an efficient allocation of resources (www.economicsonline.co.uk). In the absence of competition, a single producer has incentives to restrict supply and raise prices as much as he wants.

The harm done by a monopoly can vary widely, depending on the extent of its market power, which could derive from either demand or supply conditions. On the demand side, where there are many close substitutes for the monopolist's product, the demand facing the monopolist will be highly elastic, and hence, the scope for profitable price increases will be small. However, where substitutes are few, as with a necessity, demand will be inelastic and the scope for price increases will be large. Pricing power may be limited by geographical considerations: A single general store in a small town will find little scope for raising prices if it is cheap to go to the next town for supplies. Likewise, a country with only a single producer of automobiles will find that free trade limits the possibilities for monopolistic pricing (www.mcgraw-hillanswers.com). Consequently, economists generally focus on the scope for profitably increasing price above marginal cost as the most appropriate measure of market or monopoly ...