Conclusion Market Efficiency And Market Failure

This chapter introduced the basic tools of welfare economks—consumer and producer surplus—and used them to evaluate the efficiency of free markets. We showed that the forces of supply and demand allocate resources efficiently. That is, even though each buyer and seller in a market is concerned only about his or her own welfare, they are together led by an invisible hand to an equilibrium that maximizes the total benefits to buyers and sellers.

A word of warning is in order. To conclude that markets are efficient, we made several assumptions about how markets work. When these assumptions do not hold, our conclusion that the market equilibrium is efficient may no longer be true. As we close this chapter, lei's consider briefly two of the most important of these assumptions.

First, our analysis assumed that markets are perfectly competitive. In the world, however, competition is sometimes far from perfect. In some markets, a single buyer or seller (or a small group of them) may be able to control market prices. This ability to influence prkes is called market powet- Market power can cause markets to be inefficient bcoiusc it keeps the prke and quantity away from the equilibrium of supply and demand.

Second, our analysis assumed thai the outcome in a market matters only to the buyers and sellers in that market. Yet, in «he world, the decisions of buyers ami sellers sometimes affect people who are not participants in the market at all. Pollution is the dassic example, The use of agricultural pesticides, for instance, affects no« only the manufaclureis who make them and the farmers who use them, but many others who breathe air or drink water that has been polluted with these pesticides. Such side effects, called rxlcnw/rtras, cause welfare in a market to depend on more than just the value to the buyers and the cost lo lite sellers. Because buy-

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