What Causes Market Inefficiency (microeconomics) Assignment

What Causes Market Inefficiency (microeconomics) - Assignment Example Market failures, like most market functions, are about information. Markets work the best when they use prices to signal information to producers and consumers the social cost of an item, and allow them to choose among the best options using this information. When markets cant do so, they fail. One of the worst types of market failure is the externality. â€Å"An externality is an impact of an economic transaction that falls on someone outside the transaction. The nice smell of your neighbors barbecue is an example of a positive externality, and your insomnia when he buys new sub-woofers would be a negative one. These externalities are treated as rare occurrences in economic theory, but the reality is that external effects of our actions are everywhere† (Larson, 2009). Externalities in conventional economic theory are treated as a problem because they prevent producers and consumers from making efficient decisions: If a product made with more pollution costs less, then the society has to pay for pollution. But externalities have all sorts of other impacts. Financial externalities are to blame for the current meltdown: Companies like AIG externalized risk onto the rest of the economy. Global warming, pollution, habitat loss, species extinction, deforestation, and ind ustrial accidents hurting workers are all examples of externalities. Externalities, unfortunately, have an almost infinite number of sources. Any market that involves industrial production, for example, can have pollution as an externality. The same thing is true of any agricultural market that uses deforestation as a mechanism to gain real estate. If it is cheaper to overwork workers, or have them in unsafe conditions, even considering legal liability, then unsafe working conditions will be an externality caused by the expensiveness of safety mechanisms. And some industries make extensive money off of