The Changing Determinants of Economic Performance in the World Economy
Chapter 14: Changing nature, extent and pervasiveness of market failures
The starting point of neoclassical economics is competitive and efficient markets. Such ‘perfect’ markets presuppose, inter alia, that economic agents have perfect information, firms are maximizing their profits and consumers their utility, productive resources are perfectly mobile among different uses and economic activities and exchanges involve no externalities to third parties. When real markets approximate these ideal conditions, they can efficiently coordinate millions of interdependent economic decisions and activities without any central authority. As Adam Smith pointed out in his Wealth of Nations the ‘marvel of the market’ is achieved unconsciously: Every individual endeavors to employ his capital so that its produce may be of greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it (Smith  1947, italics added). But do markets really approximate the ‘perfect’ model? Where exactly is the price mechanism superior to the other forms of economic organization? Competitive markets generally involve numerous well-informed buyers and sellers who transact in rather simple and standardized products. Markets for many basic consumption goods, raw materials, natural resources and financial instruments meet these criteria (Boyer 1997; Kuttner 1997). However many markets for durable goods (automobiles, washing machines etc...
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