Economists often assume that markets are perfectly competitive and that all information necessary to make rational decisions is available.
. But this is not always true. Sometimes the market is far from being competitive, there is lack of adequate information for participants, and a single buyer or seller,
or a small group of buyers and sellers, may be able to control market prices. This power exercised by monopolists and oligopolists is called market power. Market power can cause markets to be inefficient, keeping price and quantity away from the supply-and-demand equilibrium (Mankiw, 1998. Samuelson and Marks, 1995). There are instances when society as a whole is not well served. therefore, it is incumbent on the government to intervene, usually for two reasons: to promote efficiency (enlarging the economic pie), and to promote equity (ensuring a better division of the pie).
To make their analysis simple, economists often assume that market outcomes matter only to the buyers and sellers, but in real life decisions by market participants sometimes affect people who had nothing to do with the market at all. Such side effects, called externalities, cause welfare to hinge on more than just values and costs when buyers and sellers decide how much to consume and produce, thus the market equilibrium can become inefficient from the viewpoint of society as a whole.
Market power and externalities are what constitute market failure – which means that the market, unregulated and left on its own, fails to allocate resources efficiently. When markets fail, public policy may be able to provide a remedy to the problem situation and perhaps increase economic efficiency. The government intervenes in the hope of improving market outcomes.