Market distortion

In neoclassical economics, a market distortion is any event in which a market reaches a market clearing price for an item that is substantially different from the price that a market would achieve while operating under conditions of perfect competition and state enforcement of legal contracts and the ownership of private property.

In this context, "perfect competition" means:

  • all participants have complete information,
  • there are no entry or exit barriers to the market,
  • there are no transaction costs or subsidies affecting the market,
  • all firms have constant returns to scale, and
  • all market participants are independent rational actors.

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

  • any policy or action that restricts information critical to the market,
  • monopoly, oligopoly, or monopsony powers of market participants,
  • criminal coercion or subversion of legal contracts,
  • illiquidity of the market (lack of buyers, sellers, product, or money),
  • collusion among market participants,
  • mass non-rational behavior by market participants,
  • price supports or subsidies,
  • failure of government to provide a stable currency,
  • failure of government to enforce the Rule of Law,
  • failure of government to protect property rights,
  • failure of government to regulate non-competitive market behavior,
  • stifling or corrupt government regulation.

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