to Public Finance:
we begin with the public finance, we would like to point out the major functions
of a modern government:
(a) Improving economic efficiency
(b) Making the distribution of income less unequal
(c) Stabilising the economy through macro-economic
(d) Representing the country internationally
is duty of the government to bring economic and social justice in the country.
And this can only be done by properly utilising the funds raised through
taxes and other sources of public finance.
famous American Economist J.M. Keynes has revolutionised and
changed the meaning of public finance. According
to Keynes, public finance should be used as an instrument for achievement of
certain economic and social objectives. Before
Keynes, the concept of public finance was to raise sufficient revenues for
meeting public expenditure. In
other words, before Keynes, public finance was concerned with the raising of
financial resources for the State. But
Keynes made a fundamental change in the nature and scope of public finance.
Keynes and his followers emphasised that public finance is to help in the
achievement of certain social and economic objectives and finance some essential
underlines the fact that the taxation and public expenditure policy of the State
vitally affects the level of income and employment in the country.
Keynes showed that during depression, how a government could reduce the
depression from the economy by increasing its public expenditure and raise the
level of employment. When the government increases its investment expenditure on
public works, then the level of income and employment in the country increases
more than the ratio of increase in initial investment.
This is Keynes' Income Multiplier.
the level of full employment in the economy is impossible.
This is so because whenever there is lack of effective demand, the
production remains unsold which ultimately leads the entrepreneur to loss.
Thus investor will reduce the level of investment resulting more
unemployment and a situation of depression in the economy.
In depression, the purpose of budgetary policy is to provide investment
opportunities and increase employment level in the economy.
The government should increase public expenditure during depression more
than the public revenue. The
deficit can be covered by deficit financing, i.e., by creating money.
The result of deficit financing is that the purchasing power with the
people increases and aggregate demand for goods and services increases.
Owing to increase in aggregate demand and the operation of multiplier,
the depression will tend to disappear and the economy will move towards full
the contrary, whenever, there is a higher effective demand and when the money
supply is increased, there will be a generation of inflation in the economy.
In such a situation, the purpose of fiscal policy to reduce money supply
in the economy so as to reduce the inflationary pressure and so people can save
more and consume less. When there
is inflation in the economy and the prices are soaring higher and higher, the
government should levy heavy taxes and in this way withdraw purchasing power
from the people and should also reduce its own expenditure.
The demand having been reduced in this way, prices would tend to come
down. It is clear that to fight
inflation, the government should frame a 'surplus budget'.
A surplus budget means that the government should collect more money from
the public by imposing more taxes but keep its expenditure less than the revenue
raised. The result will be that
less purchasing power will be left with the people and the aggregate demand for
goods will be reduced. Consequently,
the prices will have a tendency to fall.
above situation is mostly existed in economically advanced and rich countries.
The less developed countries, like Pakistan, Bangladesh, India, China,
Myanmar, etc. are caught up in the vicious circle of poverty and their main
problem is to break this circle and move towards economic development so that
poverty is removed and the living standard of the people is raised.
The objectives of public finance in less developed countries are to give
a fill up to capital formation, encourage industrialisation, encourage
productive investment, and foster economic growth.
Thus the objectives of public finance in less developed countries are
different from those in the developed countries.
Whereas in developed countries, the function of public finance is to
accelerate economic growth so that the widespread unemployment and poverty
prevailing in the country are removed.
Causes of Market Failure / Reasons of Government's Intervention in Market Economy:
market economic system operates under Price Mechanism. Consumers show their will or desire to buy a commodity at a
given price in order to maximise their utility.
On the other hand, the producers are aimed at maximising their profit for
what they produce. In market
economy, there is no justification for state intervention but there are some
reasons that necessitate the government's intervention in the economy as
To avoid Monopoly: Monopoly is a situation in which one seller rules over the whole
industry. The buyers are compelled
to purchase commodity at the price fixed by the monopolist.
Therefore, the government interferes for the benefits of the consumers.
The government interferes in pricing of the commodity, and/or encourages
new firms to enter into the market/industry.
To maintain Price Mechanism: There may be possibilities of prevailing an unjustified price mechanism
even in the presence of perfect competition in the market.
The government can monitor the prices fixed by the market and protect the
consumers from the burden of unjustified prices.
To meet Externalities: Externalities represents those activities that affect others for better
or worse, without those others paying or being compensated for the activity.
Externalities exist when private costs or benefits do not equal social
costs or benefits. There are two
major species, i.e., external economy and external diseconomy.
In such situation, government intervene the market with its different
Increasing Social Welfare and Benefits:
Another strong reason of government's intervention in the market economy is the
social welfare and benefit. It is
one of the duties of an elected government to work for the common welfare of the
nation; to provide social goods and services, like hospitals, education
facilities, parks, museums, water and sewerage, electricity, old age benefits,
scholarships, etc; and the protect the people from the evils of a laissez faire
To meet Modern Macro-Economic Issues:
It is the duty of the government to ensure that the country is in a right
direction of economic development. Government
must ensure controlled inflation, greater employment opportunities, rapid
technological advancement, adequate capital formation, and higher economic
Governmental Activities / Actions taken by the Government:
of government in the economy takes a number of forms. The government may undertake the conduct of production, or
may influence private economic activity by subsidies or taxes, or they may
exercise direct control over behaviour on the private sector. Finally, governments may transfer purchasing power from some
persons to others. The government
activities can be broadly classified into four groups:
Allocative Activities: These activities alter the overall mix of gross national product.
The allocative activities arise out of the failure of the market
mechanism to adjust the outputs of various goods in accordance with the
preferences of society. The
ultimate goal of the government is to maximise per capita income.
Efficiency in Resource Utilisation:
Maximum efficiency in the use of resources requires the attainment of three
(i) Attainment of least cost combinations
(ii) Operation of the firms at the lowest
long-run average cost
Provision of maximum incentive for developing and introducing new techniques.
the private sector is presumed to be less deficient, on the whole, in attaining
optimal efficiency than in attaining optimal allocation of resources,
nevertheless in several situations governments may be more effective.
Stabilisation and Growth Activities:
are those activities reducing economic instability and unemployment and
increasing the potential and actual rates of economic growth.
Distributional Activities: are those activities altering the pattern of distribution of real
Approaches of Government Actions:
are the approaches or tools of government action plan against the malfunctions
of market economy:
Governmental Conduct of Production:
The public goods such as defence, law enforcement, etc are supplied by the
government, since their inherent character they cannot be produced and sold on a
profit-making basis by private enterprise.
may also undertake education. In
order to adapt the nature and quality of education to meet community goals,
governments produce the services directly, although allowing private enterprise
to provide them as well for persons who prefer the private product.
conduct of production may also be undertaken for efficiency reasons - to avoid
collection costs, to obtain advantages of longer-term investments, or to attain
economies of scale.
The Subsidy Approach: An alternative to governmental production is subsidisation of private
producers to induce them to increase output or to undertake investments that
they would not otherwise make. Thus
private schools could be subsidised to provide additional education at prices
less than those equal to marginal cost. Subsidies
might also be used to increase investment to lessen unemployment or to lower
output when carried beyond the optimal figure.
The Control Approach: For some purposes, direct control of private sector activity, with no
governmental production except the limited amount involved in administration of
the regulatory rules, is a satisfactory solution. Activity that gives rise to significant external costs, such
as pollution, may be subjected to controls, such as requirements for adequate
waste disposal. Monopoly may be
broken up by antitrust laws or monopoly firms may be subjected to detailed
regulation of rates and services. This
form of regulation creates a continuous clash of interest between government and
Aggregate Spending: Prevention of unemployment and attainment of the potential rate of
economic growth or prevention of inflation may require fiscal and monetary
policies that influence aggregate demand in the economy.
To eliminate unemployment the government may raise the level of public
spending and the scope of its activities beyond the levels as warranted, or may
reduce taxes below the optimal levels.
Transfer Payments: Transfer payments are made by the government for bringing down the
inequality in income distribution more closely in line with the desired one.
Transfer payments may be 'specific' or 'non-specific', for example,
scholarships in universities are specific, and provision of education and parks
free of charge is non-specific. Non-specific
transfer payments or general transfer payments are made on the basis of the
income status of the recipients in conjunction with various criteria of needs.
For example, old age benefits, aid for dependent children, direct relief,
or negative income tax.
Pareto Optimality / New Welfare Economics:
New Welfare Economics represents a break with the utilitarian tradition in
Economics. The new welfare
economists claim to arrive at optimum conditions of production and exchange
without adding the utilities of different persons or comparing the satisfactions
of different individuals. The new
welfare economics is claimed to be objective and scientific and not ethical.
It is said that welfare economics furnishes an analysis of the causes
governing the measure of welfare or an increase or decrease thereof.
Italian born Vilferdo Pareto is said to be the pioneer of new welfare
economics, although there have been introduced some subsequent refinements since
Italian Economist Vilferdo Pareto has laid down the conditions for
maximising social welfare or for achieving a social optimum. A Paretian optimum refers to a situation in which it is
impossible to make any one better off without making some one worse off.
For judging such a situation, Pareto has enunciated a very simple and
straightforward criterion thus: "Any change which harms no one and which
makes some people better off (in their own estimation) must be considered to be
the following diagram, an example of a community is taken, in which there are
only two persons X and Y:
utility of X is represented along horizontal axis and that of Y along the
vertical axis. The Pareto criterion
states that if we start off from a situation which is represented by a point
like A, then a policy change by the Government is an improvement if it results
in a move to any point like B or C which lies to the right of A or above.
At B, X is better off than at A with Y as well off as before, whereas the
move to C benefits Y without harming X and the move to D, benefits both the
Conditions of Paretian Optimum:
conditions of Paretian optimum are given below:
Optimum Allocation of Products:
Allocation of products to be optimal must be such as to make it impossible for
any pair of individuals to exchange any quantity of any pair of consumer goods
resulting in increase in one's satisfaction without decreasing that of another. That is, if any alternative allocation can increase some
one's satisfaction without decreasing another's, it is not optimal.
To put in terms of indifference curve technique, the marginal rate of
substitution (MRS) between any two good must be same for any pair of owners of
the same two goods. We know that MRS is the rate at which units one good can be
exchanged for the units of another without lowering the level of satisfaction.
can be explained with the help of an Edgeworth Box diagram.
The Edgeworth diagram for consumption shows the indifference curve
preference maps of the two individuals and their derived levels of satisfaction
from the various combinations of goods. The
indifference curve preference maps of both A and B have been combined and shown
with the help of an Edgeworth Box in the following figure:
indifference curve preference map of A starts from origin O, whereas the
indifference curve preference map of B starts from origin O'.
I1 to I8 represents the indifference curves of
individuals A and B. I1, I2, I3 and I4
represent the indifference curves of individual A, and I5, I6,
I7 and I8 represent the indifference curves of individual
B. The slope of an indifference
curve, as we know, at any point is the marginal rate of substitution between
commodities X and Y (MRSxy). The
point would be optimal where the MRSxy of both individuals are same.
If the MRSxy is not the same, then with the help of exchange,
it is possible to increase the level of satisfaction of one without diminishing
that of the other. Now if we joint
the points L, M, N, P where the different sets of indifference curves of
individuals A and B are tangent to each other, we get a curve known as 'Contract
Curve', i.e., cc'. The points
L, M, N and P lie on the contract curve cc'.
At each of these points, the MRSxy for A and B is the same.
Therefore, each point along a contract curve cc' represents a point of
Pareto-optimality. In other words,
any redistribution of the goods X and Y between A and B will yield a lower level
Optimum Degree of Specialisation:
It refers to the condition that the marginal rate of transformation (MRT)
between any two goods must be the same for any pair of firms producing both of
them. The MRT between two goods is
the amount of one good which would have to be sacrificed to produce one unit of
another good. This only means the ratio of marginal opportunity cost of the
two goods. Obviously, if MRT is not
the same for any pair of producers, it would be possible to increase the
combined output of the two goods or increase the output of one without
decreasing that of another. This
will mean that the present degree of specialisation is not the optimum.
Optimum Factor Utilisation: This represents optimum relationship between the factor and the product.
The utilisation of a factor will be optimal if the marginal rate of
transformation (MRT) between any factor and any product is the same for any two
firms using the factor and producing the product.
If MRT is not the same, it will be a departure from the optimum.
Optimum Allocation of Factors: All factors of production must be so allocated among the various uses
that the marginal production in each use is that same.
If it is not the same, it will pay to shift some units of a factor from
one use to another. In terms of new economics, the marginal rate of technical
substitution (MRTS) between any pair of factors must be the same for any two
firms using both to produce the same product.
Only then, the allocation will be optimal. If it is not, it will be possible to increase the total
product by shifting a factor from one firm to another.
Optimum Direction of Production:
Another condition for maximising welfare is that the marginal rate of
substitution between any pair of products for any person consuming both must be
the same as the marginal rate of transformation for the community between them.
In terms of utility analysis, it means:
(i) That the ratios of marginal utilities of the two goods must be the
same for all consumers, i.e.,
MU of A
= MU of B
Price of A
Price of B
This will represent maximum satisfaction of the consumer.
(ii) The ratio of their marginal costs must be the same for all producers
producing them, i.e.,
MC of A
= MC of B
Price of A
Price of B
(iii) These ratios must be equal.
condition relates to the maximum efficiency of the economic system.
The goods must be produced in such combinations that they not only
conform to consumers' preferences but are also produced at the minimum average
cost. If it is technically possible
to substitute one good for another and make one better off without making
another worse off, the production is not optimal.
us take a community producing two goods. The
quantity of each good it produces will depend on its factor endowments and on
its existing technical knowledge. By
factor endowments we mean the amounts of factors of production the community
possesses. Let us assume that the
community can produce either 100 bushels of wheat or 100 yards of cloth when all
its factors are fully and most efficiently employed in the production of either
wheat or cloth respectively. The
various combinations of wheat and cloth that it can produce are shown by the
'production possibility curve' or the 'transformation curve'.
If the community chooses to produce wheat only, it can produce 100
bushels. If it would also like to
produce cloth, it must forgo the production of some of its wheat.
The amount of wheat, which the community foregoes in order to have an
extra unit of cloth, is known as the 'opportunity cost' of wheat in terms of
the following diagram, the community's production possibility curve drawn on the
assumption of increasing opportunity cost.
The meaning of increasing opportunity cost is that the amount of extra
wheat the community produces by decreasing production of cloth with given
factors is steadily increasing.
us superimpose the indifference curve preference map, i.e., I1 and I2
of an individual A on AB production possibility curve.
Now the Pareto-Optimal point would be where the slope of production
possibility curve AB and of the indifference curve (A) is the same or tangent.
In this diagram, point P is the optimal point, as the slope of the
indifference curve I2 and PB on curve AB is the same.
The point Q is not the point of optimum.
Optimum Allocation of a Factor-Unit's Time:
The owner of a factor unit has the option of using the factor to render him a
direct service or hiring it out to others for aiding in production.
Hence, the problem for the owner of a factor is to allocate the time of
factor rendering direct services or working for a money reward in an optimal
Inter-Temporal Allocation of Assets:
Every individual firm has to bring about an optimal allocation of factor inputs
and product output over time. A
firm may produce a given output stream with various time patterns of factor
inputs and conversely, it may have various time patterns of outputs with a given
input stream of factor services. It
refers to the allocation of products or factors that may relate to different
moments of time. In this case, the allocation will bring maximum welfare when
the marginal rate of substitution between any pair of moments is the same for
every pair of individuals or firms.
above-discussed conditions are also known as 'First-Order Conditions'.
From the above first-order conditions, the Pareto-Optimality can be
attained. But the fulfilment of
these first-order conditions may not be enough to lead to welfare optimality.
To achieve an optimum welfare position, it is very necessary that the 'Second-Order
Conditions' along with the first order conditions should also be satisfied
to achieve the maximum welfare. These
second order conditions are no other than the stability conditions for
equilibrium position. The
fulfilment of second order conditions means that all the indifference curves and
the production possibility curves should have the right curvature in the
neighbourhood of any position where marginal conditions are satisfied.
In the neighbourhood of maximum welfare, all indifference curves must be
convex to the origin and all transformation curves must be concave to it.
the following figure, AB is the production possibility curve of the community, I1
and I2 are the indifference curves of an individual.
The point b is a point of optimum welfare as the indifference
curve I2, is a tangent to the production possibility curve AB.
At point a, the indifference curve I1 is also a tangent
to the production possibility curve AB but it is not a point of optimum welfare,
as by moving from a to b, the community reaches on a higher
indifference curve I2.
Relation between Pareto Optima and Perfect Competition:
Equality of Marginal Rate of Substitution:
Under conditions of perfect competition, the consumer in order to maximise
satisfaction makes the marginal rate of substitution between any two goods equal
to the ratio of their prices. At
equilibrium, the MRS between two goods is equal to the ratio of their prices for
any consumer. Therefore, the first condition of optimum allocation of goods
of Pareto-optimality is satisfied under perfect competition.
Equality of Marginal Rate of Transformation b/w Two Factors:
Under conditions of perfect competition, in order to have minimum cost
combination of the factors to produce a given output tries to equate the
marginal rate of transformation (MRT) between two factors to the ratio of their
prices. At equilibrium, this condition of equating MRT between two
factors to the ratio of their prices is satisfied. Hence, the condition about the optimum allocation of factors
is also satisfied.
Equality of Marginal Rate of Transformation b/w Two Commodities:
The producer under perfect competition, in order to maximise the profits, tries
to equate the marginal rate of transformation (MRT) between two commodities to
the ratio of their prices. At
equilibrium, this condition of equating MRT between two commodities to the ratio
of their prices is satisfied. Hence,
the condition about the optimum utilisation of a factor is satisfied.
Equality of Marginal Product of Each Factor:
The producer in order to maximise his profits tries to equate the marginal
product of each factor to its price and, at equilibrium, this condition is
satisfied. Therefore, the condition
of optimum factor-product relationship is satisfied.
Equality of MRS to MRT b/w Two Commodities:
Under perfect competition, at equilibrium, the marginal rate of substitution (MRS)
between the two commodities is equal to the marginal rate of transformation (MRT)
between the two commodities and both are equal to the ratio of their prices.
Therefore, the condition about the optimum direction of production is
Equality of MRS & MRT: Under perfect competition, a factor will be utilised to the point where
the marginal rate of substitution (MRS) between employment of the factor and its
leisure equals the rate of payment made to it. Similarly, with a view to maximising his profit, a producer
equates the MRT between the factor and its product. Since the price of the product is the same for all the
producers and rate of payment is the same for all the factor units, the
condition of optimum allocation of a factor unit's time is also satisfied.
Equality of Marginal Productivity of Asset:
An owner of an asset makes the MRS between present income and future income
equal to his rate of time preference. In
the same way, a borrower of the asset equates the cost of borrowing with the MRS
between the present asset and future asset.
Since under perfect competition, the rate of payment for all similar
assets is the same, as also the cost to the borrowers, it is equal to the
marginal productivity of the asset. In
this way, the condition of inter-temporal optimum allocation of assets is also
fulfilled under perfect competition.
the above it is clear that under perfect competition all the marginal conditions
of Paretian-optimum are satisfied.
Obstacles to Welfare Maximisation:
maximum welfare is to be attained, optimum allocation of factors of production
is essential. This allocation must
be in keeping with the consumer's preferences.
For this purpose, there must prevail perfect competition. But, in the real world, there is no perfect competition,
instead there is imperfect competition. This
constitutes a big obstacle in the way of the attainment of maximum welfare.
We shall see how different forms of imperfect competition stand in the
way of welfare maximisation:
By pursuing restrictive price and output policies, the monopolists exploit the
consumers' weakness by charging exorbitant prices and by restricting output.
They reduce the national income. In
all these ways, they reduce social welfare, especially because they cause
misallocation of productive resources.
monopoly, the monopolist faces a downward sloping demand curve (instead of
horizontal straight line as under perfect competition).
Hence, the marginal revenue is less than average revenue / price.
In order to maximise profit, the producer will equate marginal cost and
marginal revenue. His marginal cost
is less than the price or price is kept higher than the marginal costs.
Thus, the monopolist does not operate at the optimum output level.
This means higher prices for the consumers and lower remuneration for the
factors of production. By creating
a divergence between factor price and the value of its marginal product, a
monopoly distorts factor allocation. Too
little resources are used in monopolised industries, which is not in conformity
with consumer's preferences.
It is a buyer's monopoly. Firstly,
take the case of monopsony in factor market, where a firm is compelled to pay
higher prices for factors in use. Hence,
the marginal cost of the factor will exceed its price per unit.
For profit maximisation, the factor will tend to be used up to a point
where its marginal cost is equal to its marginal revenue product.
But as said above, marginal cost exceeds price.
Hence, the price paid to the factor is less than marginal product.
Thus, the factor is not being paid its worth, which shows a faulty
allocation of factors which in turn militates against welfare maximisation.
the case of monopsony in product market. In
this case, the marginal cost of the product will be higher than the price paid
by the monopsonist. The quantity
purchased will be smaller and the price paid lower than under competition.
This represents misallocation of resources in the economy.
Monopolistic Competition: In this case, there are too many firms in the industry operating at less
than optimum scales of output having excess capacity which is socially wasteful.
Product differentiation compels waste.
Hence there is a reduction in social welfare.
In pure oligopoly (without product differentiation), there is a misallocation of
resources and hence a reduction of social welfare. In this case, a dominant firm determines the price and output
policy. In order to maximise
profit, the firm equates marginal cost with the marginal revenue.
But the price will exceed marginal cost and distort resource allocation.
Market Structure and Social Welfare:
the Paretian sense, if a policy change makes at least one individual better off
without making any one worse off it is said to maximise social welfare.
Let us see how this social optimum can be attained under different market
Social Welfare under Perfect Competition:
To achieve maximum social welfare under perfect competition, the allocation of
resources needs to be efficient. For
allocation of resources to be efficient, it is necessary that the MRS between
any two commodities for a consumer is equal to the MRT between these two
commodities is equal from producer's point of view.
This would lead to:
situation is possible only in perfectly competitive market.
conditions of perfect competition also bring about the equality between the
private marginal product and social marginal product. The basic condition for maximum welfare is that social
marginal utility be equal to social marginal cost:
Social Welfare =
Social Marginal Utility
equality between private marginal utility and social marginal utility will
depend upon the distribution of money income in the community.
The distribution must be such as would equalise its marginal utilities
for all the consumers. The marginal
cost of producing any alternative commodity would be the same as for the one
that is being produced. This will
lead to equality between private marginal cost with private marginal utility and
hence the social marginal utility and social marginal cost. This is how conditions of perfect competition result in the
attainment of maximum social welfare.
The conditions of efficient allocation of resources do not exist in a condition
of monopoly, therefore, the maximum social welfare cannot be attained under
monopoly. The monopoly equilibrium
is based on the equality of marginal revenue and marginal cost.
Under conditions of monopoly, price is greater than marginal revenue of
output and also the marginal cost. The
inequality of price and marginal cost represents the violation of basic
condition of efficient allocation of resources and hence maximisation of social
welfare. Following things are happened under monopoly:
is thus clear that monopoly form of business is not consistent with the maximum
social welfare. Whatever the form
of monopoly, whether in the commodity market or in the factor market (monopsony),
it works as a hindrance to the achievement of maximum social benefits.
Monopolistic Competition: Under monopolistic competition, efficient allocation of resources is not
as possible as compared to perfect competition. Under monopolistic competition, in the short run, the demand
curve is not tangential to the average cost curve at its lowest or optimum
point. On the other hand, the
demand curve is tangential to the average cost curve at a point higher than the
optimum scale point. It is shown in
the following diagram:
the levels of output are not optimum, the allocation of productive resources
under monopolistic competition cannot be termed as efficient as in the case of
perfect competition. If social
welfare is to be maximised there must be fullest use of installed capacity.
However, in the long run, the total efficiency achieved can be summed up
to the level of maximum social welfare. Because
in the long run, the long run average revenue curve or the demand curve is
tangent to the long run average cost curve at its lowest point or the optimum
point. Which is because of greater divisibility of the factors of
production in the long run. In the
long run, the indivisible factors of production can be used more economically
because, in the long run, they are, in fact, to extent, divisible.
In the long run, the cost curves depend on 'returns to scale'.
In the long run, the amount of capital can be altered and the management
can be arranged differently. If all
the factors of production can be used in varying proportions, it means that the
scale of operations of the firm can be changed.
Consider the following diagram:
the above diagram the industry is said to be producing at its technically
optimum output level, i.e., OM. Output
is optimum in the sense that average cost is at a minimum.
short, under monopolistic competition, the maximum social welfare can be
sufficiently attained, but not as much as compared to the perfect competition.
So far as there is product differentiation, monopolistic competition
offers greater product variety as compared to perfect competition.
Under perfect competition, the products are homogenous, where the
distinctive characteristic of monopolistic competition is product
differentiation on bases of design, style, quality, income, age, sex, etc.
Each product variety represents different taste and temperament of
consumers, and gives better satisfaction to different classes of consumers.
Under oligopoly, there is misallocation of resources. Under oligopoly, few producers/sellers often form a cartel to
have a tight grip on the market and a super-normal profit.
Consumers and labourers are the worse victims of this form of market
structure. The sellers may almost
destroy the social interest and may work for their own interests.
There are various global examples of oligopoly including OPEC (Organisation
of Petroleum Exporting Countries). That
is why oligopoly is not considered as the best companion of the governments
around the world to achieve social welfare.
Misallocation of resources is due to the fact that the market leader
determines the price of the commodity for the entire industry.
This price is calculated to yield maximum profit, i.e., where firm's
marginal cost is equal to marginal revenue.
Since price is higher than marginal cost, it results in misallocation of