Some of the major reasons for the failure of free market mechanisms are as follows:
(a) Inequitable Distribution of Goods and Job Opportunities (b) Existence of Perfect Competition (c) Judgment of Individuals (d) Emphasis on Profit (e) Low Priority for Public Utilities (f) Growth of Monopolies.
The government of a country has major contribution for the growth and development of the economy. It strives to attain economic growth by making optimal allocation of resources and working for social welfare.
However, classical economists believed that the role of government in an economy should be prohibited. In addition, they propounded that the economy adjusts itself without any controlling unit. However, these conditions are not applicable in the real world. For example, at the time of Great Depression of 1930s, the economy could not recover on its own.
Besides this, there are several other reasons for the failure of free market mechanism, which are as follows:
(a) Inequitable Distribution of Goods and Job Opportunities:
Acts as one of the major reasons for the failure of the free market mechanism. According to Slither, in the free market mechanism, there are two requirements of an economy that need to be fulfilled. Firstly, in an economy, goods should be distributed among those individuals who can take out maximum pleasure by consuming those goods.
Secondly, the task of producing goods should be handed over to those individuals who can perform them more efficiently without incurring extra effort. In economic terms, goods should be distributed in a manner so that the marginal utility of each good is same for all consumers in an economy.
On the other hand, resources should be allocated in such a way that the marginal productivity of each factor of production is same for all industries. However in the free market mechanism, the goods and resources are not allocated in such a manner as stated by Slither.
In the free market mechanism goods are distributed among those individuals who can pay highest prices for them, irrespective of marginal utility driven by those goods. Therefore, in such a case, the assumption that satisfaction achieved from a good is proportional to the ability to purchase the good does not hold true.
The level of satisfaction of poor and rich for the same product can be different. For example, an idle clothing of a rich man would provide more satisfaction to a poor. This is because of the reason that the purchasing power of a poor is low as compared to the rich person; therefore, he/she would not be able to get the apparel that belong to the rich person.
Similarly, in the free market mechanism, jobs are not allocated in a way that individuals can perform them without putting extra efforts. Apart from this, in the free market mechanism, individuals do not receive wages according to their productivity. In an economy various unproductive labor, such as bureaucrats, politicians, and commission brokers get a much higher salary than a productive person.
(b) Existence of Perfect Competition:
Refers to another shortcoming of the free market mechanism. In the free market mechanism, the existence of perfect competition is important for the proper and efficient working of an economy. Apart from perfect competition, the other conditions under the free market mechanism for the efficient working of an economy are increasing production cost in every market, exclusion principle of consumption, non-existence of public goods, perfect knowledge of buyers and sellers, and mobilization of factors of production.
However, the perfect competition does not exist in the real world situation. Moreover, perfect competition alone is not responsible for the efficient working of the economic system. For example, if social and private costs are not same, then also the economy would not function properly even under perfect competition.
(c) Judgment of Individuals:
Implies that the free market mechanism is based on an assumption that individuals are always the best judge of their needs, tastes, and preferences. Therefore, decisions taken by individuals regarding their choices would also be the best.
However, the buying behavior of individuals, especially for consumer goods, is influenced by various factors, such as impulses, habits, prejudices, and evaluation and comparison among alternative products. Thus, the choices of individual’s are not totally dependent on their own decision, but also get influenced by a number of factors. Therefore, the decisions of individual cannot always be the best.
(d) Emphasis on Profit:
Refers to the fact that profit is considered as the main element of motivation for private entrepreneurs under the free market mechanism. Therefore, entrepreneurs should not invest in the industry that is not profitable or less profitable as compared to other industries, even if that industry plays an important role in the economic development of the nation.
On the contrary to this, in present monopolistic and oligopolistic markets, maximization of profit leads to underutilization of resources. This further result in low output and employment.
(e) Low Priority for Public Utilities:
Constitutes the major part for the failure of the free market. Public utilities, such as medical care, education, water, and electricity are equally important for all individuals in an economy, regardless of rich or poor. Apart from this, other facilities, including transport and communication, play a crucial role in the economic development of a country.
These facilities are known as socio-economic infrastructure. However, private entrepreneurs do not prefer to invest in these sectors due to various reasons, such as high initial investment and low returns. Besides this, public utilities are consumed collectively under which the principle of exclusion in pricing cannot be applied. In case, the public utilities are owned and governed by the private sector, then the individuals from high-income group would be able to avail these utilities. As a result, there would be inequitable distribution of essential resources.
(f) Growth of Monopolies:
Acts as another important reason for the failure of the free market mechanism. The free market mechanism works under the condition of perfect competition. In perfect competition, there should be equality among all competitors.
However, in the real world scenario, competitors cannot be alike in efficiency, which leads to the situation of imperfect competition. It is a well-known fact that imperfectly competitive markets can never be perfectly competitive. This results in the growth of monopolistic and oligopolistic competition. The growth of private monopolies results in various economic problems, such as low production, low employment, and high prices.
Due to the aforementioned reasons, the free market mechanism failed to attain the major objectives of an economy. For example the free market mechanism was unable to achieve proper allocation of goods and jobs and optimum utilization of scarce resources. Instead of achieving the objectives of the economy, the free market mechanism resulted in the growth of private monopolies, improper distribution of income, and increase in poverty and unemployment.
However, the free market mechanism helped in the growth of the economy, but was not able to maintain and sustain such growth. In such a situation, the intervention of government became very important for the growth of an economy.