neoclassical economics Neoclassical economics is an approach to economics in which the production, consumption, and valuation (pricing) of goods and services are observed as driven by the supply and demand model. According to this line of thought, the value of a go ...

, a market distortion is any event in which a market reaches a

market clearing In economics, market clearing is the process by which, in an economic market, the supply of whatever is traded is equated to the demand so that there is no excess supply or demand, ensuring that there is neither a surplus nor a shortage. The new ...

price for an item that is substantially different from the price that a market would achieve while operating under conditions of

perfect competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...

and state enforcement of

legal contract A contract is an agreement that specifies certain legally enforceable rights and obligations pertaining to two or more parties. A contract typically involves consent to transfer of goods, services, money, or promise to transfer any of those a ...

s and the

ownership Ownership is the state or fact of legal possession and control over property, which may be any asset, tangible or intangible. Ownership can involve multiple rights, collectively referred to as '' title'', which may be separated and held by dif ...

private property Private property is a legal designation for the ownership of property by non-governmental Capacity (law), legal entities. Private property is distinguishable from public property, which is owned by a state entity, and from Collective ownership ...

. A distortion is "any departure from the ideal of perfect competition that therefore interferes with economic agents maximizing social welfare when they maximize their own". A proportional wage-income tax, for instance, is distortionary, whereas a

lump-sum tax A lump-sum tax is a special way of taxation, based on a fixed amount, rather than on the real circumstance of the taxed entity.

is not. In a competitive equilibrium, a proportional wage income tax discourages work. In

with no externalities, there is zero distortion at market equilibrium of

supply and demand In microeconomics, supply and demand is an economic model of price determination in a Market (economics), market. It postulates that, Ceteris_paribus#Applications, holding all else equal, the unit price for a particular Good (economics), good ...

where

price A price is the (usually not negative) quantity of payment or compensation expected, required, or given by one party to another in return for goods or services. In some situations, especially when the product is a service rather than a ph ...

equals

marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is increased, i.e. the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it ...

for each firm and product. More generally, a measure of distortion is the deviation between the market price of a good and its marginal

social cost Social cost in neoclassical economics is the sum of the private costs resulting from a transaction and the costs imposed on the consumers as a consequence of being exposed to the transaction for which they are not compensated or charged. In other w ...

, that is, the difference between the

marginal rate of substitution In economics, the marginal rate of substitution (MRS) is the rate at which a consumer can give up some amount of one good in exchange for another good while maintaining the same level of utility. At equilibrium consumption levels (assuming no ext ...

in consumption and the

marginal rate of transformation Marginal may refer to: * ''Marginal'' (album), the third album of the Belgian rock band Dead Man Ray, released in 2001 * ''Marginal'' (manga) * '' El Marginal'', Argentine TV series * Marginal seat or marginal constituency or marginal, in polit ...

in production. Such a deviation may result from government

regulation Regulation is the management of complex systems according to a set of rules and trends. In systems theory, these types of rules exist in various fields of biology and society, but the term has slightly different meanings according to context. Fo ...

monopoly A monopoly (from Greek language, Greek and ) is a market in which one person or company is the only supplier of a particular good or service. A monopoly is characterized by a lack of economic Competition (economics), competition to produce ...

tariff A tariff or import tax is a duty (tax), duty imposed by a national Government, government, customs territory, or supranational union on imports of goods and is paid by the importer. Exceptionally, an export tax may be levied on exports of goods ...

s and

import quota An import quota is a type of trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time. An import embargo or import ban is essentially a zero-level import quota. Quotas, ...

s, which in theory may give rise to

rent seeking Rent-seeking is the act of growing one's existing wealth by manipulating the social or political environment without creating new wealth. Rent-seeking activities have negative effects on the rest of society. They result in reduced economic effic ...

. Other sources of distortions are uncorrected

externalities In economics, an externality is an indirect cost (external cost) or indirect benefit (external benefit) to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced ...

, different tax rates on goods or income,

inflation In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...

, and incomplete information. Each of these may lead to a net loss in social surplus.• T. N. Srinivasan (1987). "distortions," '' The New Palgrave: A Dictionary of Economics'', v. 1, pp. 865-67.
• Joel Slemrod (1990). "Optimal Taxation and Optimal Tax Systems," ''Journal of Economic Perspectives'', 4(1),
p. 157
178. Market distortions are events, decisions, or interventions taken by governments, companies, or other agents, often in order to influence the market. They are often the response on market failures, i.e., circumstances that prevent perfect competition and achieving an optimal equilibrium in the market. In the context of markets, "perfect competition" means: * all participants have complete information, * there are no

entry Entry may refer to: *Entry, West Virginia, an unincorporated community in the United States *Entry (cards), a term used in trick-taking card-games *Entry (economics), a term in connection with markets *Entry (film), ''Entry'' (film), a 2013 Indian ...

or exit barriers to the market, * there are no

transaction cost In economics, a transaction cost is a cost incurred when making an economic trade when participating in a market. The idea that transactions form the basis of economic thinking was introduced by the institutional economist John R. Commons in 1 ...

s or

subsidies A subsidy, subvention or government incentive is a type of government expenditure for individuals and households, as well as businesses with the aim of stabilizing the economy. It ensures that individuals and households are viable by having acce ...

affecting the market, * all firms have

constant returns to scale In economics, the concept of returns to scale arises in the context of a firm's production function. It explains the long-run linkage of increase in output (production) relative to associated increases in the inputs (factors of production). In th ...

, and * all market participants are independent

rational Rationality is the quality of being guided by or based on reason. In this regard, a person acts rationally if they have a good reason for what they do, or a belief is rational if it is based on strong evidence. This quality can apply to an ...

actors. Many different kinds of events, actions, policies, or beliefs can bring about a market distortion. For example: * almost all types of

taxes A tax is a mandatory financial charge or levy imposed on an individual or legal entity by a governmental organization to support government spending and public expenditures collectively or to regulate and reduce negative externalities. Tax co ...

and

, but especially

excise file:Lincoln Beer Stamp 1871.JPG, upright=1.2, 1871 U.S. Revenue stamp for 1/6 barrel of beer. Brewers would receive the stamp sheets, cut them into individual stamps, cancel them, and paste them over the Bunghole, bung of the beer barrel so when ...

ad valorem An ''ad valorem'' tax (Latin for "according to value") is a tax whose amount is based on the value of a transaction or of a property. It is typically imposed at the time of a transaction, as in the case of a sales tax or value-added tax (VAT). A ...

taxes/subsidies, * asymmetric information or

uncertainty Uncertainty or incertitude refers to situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown, and is particularly relevant for decision ...

among market participants, * any policy or action that restricts information critical to the market, *

oligopoly An oligopoly () is a market in which pricing control lies in the hands of a few sellers. As a result of their significant market power, firms in oligopolistic markets can influence prices through manipulating the supply function. Firms in ...

, or

monopsony In economics, a monopsony is a market structure in which a single buyer substantially controls the market as the major purchaser of goods and services offered by many would-be sellers. The Microeconomics, microeconomic theory of monopsony assume ...

powers of market participants, * criminal coercion or subversion of legal contracts, * illiquidity of the market (lack of buyers, sellers, product, or

money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are: m ...

), * collusion among market participants, * mass non-rational behavior by market participants, * price supports or subsidies, * failure of government to provide a stable

currency A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a ''system of money'' in common use within a specific envi ...

, * failure of government to enforce the

Rule of Law The essence of the rule of law is that all people and institutions within a Body politic, political body are subject to the same laws. This concept is sometimes stated simply as "no one is above the law" or "all are equal before the law". Acco ...

, * failure of government to protect

property rights The right to property, or the right to own property (cf. ownership), is often classified as a human right for natural persons regarding their Possession (law), possessions. A general recognition of a right to private property is found more rarely ...

, * failure of government to regulate non-competitive market behavior, * stifling or corrupt government regulation. * nonconvex consumer preference sets * market

* natural factors that impede competition between firms, such as occurs in

land Land, also known as dry land, ground, or earth, is the solid terrestrial surface of Earth not submerged by the ocean or another body of water. It makes up 29.2% of Earth's surface and includes all continents and islands. Earth's land sur ...

markets

References

Financial markets Economic efficiency {{microeconomics-stub

See also

References