- 1 What is market distortion?
- 2 Understanding market distortion
- 2.1 government subsidies
- 2.2 Monopoly power and market distortion
- 2.3 AlsoRead
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What is market distortion?
For free-market purists, market distortion is any situation in which prices are determined by anything except the absolute forces of supply and demand. By that definition, truly free markets are rare. In a more practical sense, market distortion means any intervention that significantly affects prices and, in some cases, risk-taking and asset allocation.
Governments are the source of most market distortions, including regulation, subsidies, taxes and tariffs. At the same time, central banks have been accused of distorting markets in recent decades with monetary policy and asset purchases. Some of the largest corporations in the world also have enough power to distort their markets.
- Market distortion is generally viewed as any interference that significantly affects prices or market behavior.
- Many government regulations are a widely accepted form of market distortion for the common good.
Understanding market distortion
Most mainstream economists decided long ago that government market distortion was necessary and desirable to protect people from the sometimes unforgiving nature of markets. Government regulations intended to protect the general well-being of all market participants are considered perverse by market purists but are widely popular.
Regulators must make a tradeoff when deciding to intervene in any market. For this reason, analysts and lawmakers strive to find a balance between the general well-being of all market participants and market efficiency in economic policy making. Although an intervention can create a market failure, it aims to increase the welfare of the society.
For example, many governments subsidize the agricultural sector, which sometimes makes farming economically viable, at least for some products. Subsidies may mean that farmers receive artificially high prices for their products, incentivizing them to produce more than they would otherwise. Although this type of intervention is not economically efficient, it helps to ensure that a nation will have enough food.
However, governments often object to each other’s market interventions. For example, the US and EU have long discussed how to address the Chinese government’s support for their own steel and aluminum markets. And many countries have opposed the protectionist trade measures of former US President Donald Trump.
Monopoly power and market distortion
A market can become distorted when a single business holds a monopoly or when other factors prevent free and open competition. This often creates problems for consumers — at least in the long run — and for their competitors. Lack of competition usually means fewer options and higher prices.
Tech giants Amazon, Facebook and Google have been accused in recent years of using their size and market power to harm competitors and engage in anti-competitive market behavior to gain greater market dominance.