1.0 Introduction

Market failure refers to a situation whereby a freely-functioning market fails to allocate resources efficiently or optimally resulting in undesirable outcomes. Main examples of market failures include market power, externalities, unequal distribution of economic prosperity and inadequate public goods.

Market power occurs when economic actors are able to exert considerable influence on market prices or the quantity of goods sold causing concentration of power and imperfect competition. Externalities are the uncompensated impact caused when the market disregard external costs of an economic activity on the well-being of a bystander. Externalities diverge social costs of benefit from the private optimum, leading to market failure as well. Unequal distribution of economic prosperity occurs as people are rewarded according to their ability in generating high income by producing things others are willing to pay off. Markets fail as significant differences in income and wealth leads to a wide gap in living standards between different groups in the economy. Market also fails when there are inadequate public goods which are not provided by the market mainly because of the free rider issue[1].

Hence public policies are required to correct market failure and increase the efficiency and productivity of the market. This ensures that the market is able to achieve the highest total social welfare, thus allowing a greater distribution of income and wealth and higher standard of living.

2.0 Public Policies

Public policies are basically described as attempts taken by the government as an approach towards public issues and are commonly incorporated in legislations, regulations, decisions and actions (Venus 2010). Examples of public policies that can be taken to remedy market failure are legislations and regulations, implementation of taxes, subsidies and price controls.

2.1 Legislations and Regulations

Legislation is a law which has been enacted by a governing body whereas regulation is a rule or restriction promulgated to control activities of businesses and consumers. There are two forms of regulations, namely industry regulation which prevents firms from gaining and exploiting excessive market control; and social regulation which protects consumers from social costs like externalities, socially undesirable goods and asymmetric information. Examples include price regulations or orders prohibiting collusive practices and monopolistic behaviours which help reduce concentration of market power. Legislations regarding the protection of the environment can also be enforced to reduce externalities like pollution.

Legislations and regulation are also an example of command-and-control policies which are specifically targeted at reducing externalities. Command-and-control policies correct externalities by regulating behaviours directly, making them either required or forbidden. This is usually carried out by respective environmental agencies or commissions of a country, for instance the Environmental Protection Agency in United States which restrict levels of pollution and emissions emitted by factories and industries.