Causes of market failure
The purpose of this assessment is to analyze the importance of government intervention for improving the state of an economy. The government intervention in a particular economy is necessary as it helps to redistribute income for improving equality of opportunity as well as equality of outcome (Ireland 2016). This study focuses on the causes of market failure and government policies for correcting market failure. The importance of monetary policy for addressing unemployment problem in Australia is also discussed in this study. The effect of monetary policy on the Australian economy is also elucidated in this study. Furthermore, the effect of change in Australian currency is also explained in this assessment.
As per Goodwin et al. (2015) market failure occurs when inefficient allocation of resources occurs in free market. It happens when price mechanism fails in allocating scarce resources effectively or market force operation leads to social welfare loss. There are some main causes of market failure, which include-
- Incomplete market- Absence of markets for certain things such as property resources and public goods is one of the reasons of market failure. Markets are missing mainly under perfect competition.
- Externalities-The existence of externalities in production as well as consumption also causes market failure. Brue et al.(2014) opines that, externalities are considered as market imperfections where market provides no price for the service. These externalities also leads to resources malallocation and causes production or consumption to fall of Pareto Optimality.
- Property resources-Another reason for market failure is general property resource. The common ownership along with open access might also lead to exploitation where the user ignores the impact of their action.
- Over provision of demerit products- Over consumption of demerit commodities also lead to negative externalities.
- Underproduction of merit products- Under production of merit products also leads to failure in market.
When market forces fail in allocating resources properly, the government might attempt to intervene policies for correcting market failure. The government might intervene in the market through several ways –
- The government might subsidize goods with positive externalities. This in turn increases supply as well as reduce product price for encouraging production or consumption of a commodity.
- The government also adopts taxation policy for reducing supply of products and therefore enhancing price for discouraging production or consumption of products.
- The government integrates rules regarding production or use of products and backs this legally via fines. This helps the government to tackle negative externalities.
There are numerous types of unemployment, which are given below-
Cyclical unemployment- This form of unemployment occurs if the economy experiences ups and downs. It occurs when wages are too high since the workers do not accept low wages. Moreover, when an economy enters into recession, several jobs lost are also considered as cyclical unemployment (Gregory and Smith 2016).
Structural unemployment-This type of unemployment occurs due to absence of certain kind of workers demand. It also occurs when existing sectors decline due to long tern changes in the market conditions.
Frictional unemployment- This unemployment occurs due to turnover in labor market and time it requires for workers in searching for new jobs. When workers change their jobs in the labor market, it also considered as frictional unemployment (Mavromaras, Sloane and Wei 2015).
The government adopts expansionary monetary policy for reducing unemployment in the nation. The monetary policy integrated involves reduction of interest rates. Lower interest rate reduces borrowing cost as well as motivate consumers for spending and investing. This in turn increases aggregate demand (AD) and declines demand deficient unemployment (Bekaert, Hoerova and Duca 2013). The government might also increase money supply for increasing consumer expenditure. The policymakers might reduce direct or indirect taxes for encouraging consumption. However, decrease in taxes on total profits might also motivate investment (Goodwin et al. 2015).
Possible government policies for correcting this market failure
During the past few years, domestic economic stability was not attained fully. Even though inflation has been slow, economic activity was slow and unemployment rate was high. Fir correcting this circumstance, the policymakers of Australia has adopted expansionary monetary policy with cuts in cash rate. The Australian government has increased aggregate demand, economic activity and reduce unemployment through adoption of monetary policy. This is explained with the help of AD- AS diagram. The initial aggregate demand curve is AD0 where economic growth and unemployment is relatively weak. This prompts RBA to integrate expansionary monetary policy and reducing cash rate. This in turn increased the spending, reduced unemployment rate and increased GDP of the Australian economy. As a result, this increased the price of goods from P0 to P1 due to existence of unused capacity in Australian economy.
Figure 1: Impact of monetary policy on Real GDP and unemployment of Australia
Source: ( As created by author)
As per Mazzucato (2015), Australia has the floating exchange rate. The value of one AUD is basically reported as nominal bilateral rate that is the rate at which per unit of Australian currency can be exchanged for another. Provided that USD is world’s major currency, the AUD/USD cross rate is considered. There are two measures of Australian dollar exchange rate such as- bilateral exchange rate and trade weighted index (TWI). The bilateral exchange rate is mainly against US dollar (AUD/USD). The Australian dollars are mainly traded against US dollar, which is considered as major medium of exchange. TWI is not the price in form of single foreign currency but the price in form of weighted average of currencies. It provides the measure of rise or fall of Australian dollar against its currencies of this nation’s trading partners. This gives more correct reflection of trade competitiveness since it involves exchange rate of the main trading partners. Furthermore, the bilateral exchange rate is also considered as vital as main proportion of this country’s trade is denominated in USD.
Exchange rate is important to the Australian dollar due to its impact on trade as well as financial flows between rest of the nations and Australia. Changes in the Australian currency impacts this country’s external industry in two ways- direct and indirect. There occurs direct impact on prices of products manufactured in this country relative to prices of commodities produced internationally (Soesmanto, Selvanathan and Selvanathan 2015). There occurs an indirect impact on the economic activity as well as inflation since variation in relative prices of commodities and services manufactured domestically influence their decisions about consumption and production. Mankiw (2015) has found out that the exports as well as imports, domestic as well as foreign investors are affected by fluctuations in exchange rate. The change in Australian currency impacts several sectors such as- mining, oil and gas and transport industries. For instance, appreciating Australian currency positively affects evolution mining but adversely affects the air transport industry. On the other hand, some companies might get positively affected by increasing Australian currency since imported customer products becomes cheaper with stringer AUD.
The change in Australian currency impacts this nation’s AD through its impact on export and import prices. Decline in Australian dollar increases import prices by assuming elasticity of demand (Brue et al. 2014). This in turn increases AD and shifts the AD curve to right, from AD0 to AD1. Thus, it creates improvement in balance of payments. On the contrary, increase in Australian currency decline aggregate demand of the nation.
Figure 2: Shift in aggregate demand due to change in Australian currency
Source: (As created by author)
Conclusion
From the above discussion, it can be concluded that intervention of the government is also vital in case of market failure. This is because if market fails in considering externalities and likely to manufacture public goods, then the government of an economy subsidizes for providing commodities with positive externalities. The policy intervention adopted by the government of respective nation also helps to overcome recessions and decrease unemployment. As fluctuations of Australian currency affects the external sector and economic performance, intervention of government aids to stabilize economic health.
References
Bekaert, G., Hoerova, M. and Duca, M.L., 2013. Risk, uncertainty and monetary policy. Journal of Monetary Economics, 60(7), pp.771-788.
Brue, S.L., McConnell, C.R., Flynn, S.M. and Grant, R.R., 2014. Essentials of economics. McGraw-Hill Irwin.
Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B. and Torras, M., 2015. Principles of economics in context. Routledge.
Gregory, R.G. and Smith, R.E., 2016. 15 Unemployment, Inflation and Job Creation Policies in Australia. Inflation and Unemployment: Theory, Experience and Policy Making, p.325.
Ireland, P.N., 2016. Monetary transmission mechanism. The New Palgrave Dictionary of Economics, pp.1-7.
Mankiw, N.G., 2015. Ten principles of economics. Principles of Economics, pp.3-18.
Mavromaras, K., Sloane, P. and Wei, Z., 2015. The scarring effects of unemployment, low pay and skills under-utilization in Australia compared. Applied economics, 47(23), pp.2413-2429.
Mazzucato, M., 2015. Innovation systems: from fixing market failures to creating markets. Revista do Serviço Público, 66(4), pp.627-640.
Soesmanto, T., Selvanathan, E.A. and Selvanathan, S., 2015. Analysis of the management of currency composition of foreign exchange reserves in Australia. Economic Analysis and Policy, 47, pp.82-89.
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