Short Answer
In market failure, the total surplus in the market decreases because resources are not allocated efficiently. This means both consumer surplus and producer surplus are reduced compared to a normal efficient market. Market failure leads to loss of welfare for society.
In simple words, market failure creates a situation where the market does not work properly. Because of this, goods are not produced or distributed in the best way, and both buyers and sellers lose some benefit, reducing overall surplus.
Detailed Explanation:
Market Failure and Surplus
Meaning of market failure
Market failure is a situation where the free market does not allocate resources efficiently. In this case, the interaction of demand and supply does not lead to the best possible outcome for society.
Market failure can happen due to reasons like monopoly, externalities, lack of information, or government interference. When the market fails, it affects both consumers and producers negatively.
Meaning of surplus in market
Surplus in microeconomics includes consumer surplus and producer surplus. Consumer surplus is the benefit buyers get when they pay less than their willingness to pay. Producer surplus is the benefit sellers get when they sell above their minimum acceptable price.
Total surplus is the sum of both and represents the overall economic welfare in the market.
Effect of Market Failure on Surplus
Reduction in total surplus
In market failure, total surplus decreases. This happens because some mutually beneficial trades do not take place.
For example, some consumers who are willing to pay for a product may not get it, or some producers who can produce efficiently may not be able to sell their goods. This reduces overall welfare.
Loss of consumer surplus
Consumers lose surplus in market failure because they may face higher prices, low availability, or poor-quality goods.
For example, in a monopoly market, prices are usually higher than in a competitive market. This reduces consumer surplus because buyers pay more and buy less.
Loss of producer surplus
Producers may also lose surplus in some cases of market failure. For example, in cases of excess regulation or lack of demand, producers may not be able to sell enough goods at profitable prices.
This reduces their benefit and discourages production.
Deadweight Loss
Meaning of deadweight loss
Deadweight loss is the loss of total surplus that occurs when a market is not efficient. It represents the value of trades that do not happen due to market failure.
Example of loss
If a good could be sold at a price where both buyer and seller benefit, but it is not sold due to market failure, then that lost benefit is deadweight loss.
Causes of Surplus Reduction
Monopoly power
When a single seller controls the market, prices are often higher and output is lower. This reduces both consumer and total surplus.
Externalities
Externalities like pollution can reduce welfare by creating costs not reflected in market prices. This leads to inefficient production and lower total surplus.
Lack of information
When buyers or sellers do not have complete information, they make wrong decisions, leading to lower surplus.
Impact on Market Efficiency
Inefficient resource allocation
Market failure causes resources to be used in the wrong areas. Goods may not go to those who value them most, reducing total benefit.
Reduced welfare
Both consumers and producers receive less benefit than they would in a perfect market. This reduces overall economic welfare in society.
Real life examples
Monopoly market
In a monopoly, prices are high and output is low. Consumers lose surplus, and total surplus is reduced.
Pollution case
In industries causing pollution, social cost is higher than private cost. This leads to overproduction and loss of total surplus.
Conclusion
In market failure, total surplus decreases because the market does not function efficiently. Both consumer surplus and producer surplus are reduced, leading to deadweight loss and lower economic welfare. Market failure causes inefficient resource allocation, which harms both buyers and sellers in the economy.