What is Market Inefficiency?
Market inefficiency can be termed as a state of affairs where the current market prices are not able to replicate the data with regards to demand and supply (Mankiw, 2009). It can also be explained as the price in the financial market that gives the impression of a distorted market hypothesis. This state can be caused by various factors such as unfair competition, deficiency in the market transparency and other factors (Mankiw, 2009).
The main objective of investment on money that has been put on the stock market is to make proceeds. However, most investors do not stop at that; they also seek means of outperforming the market (Pedersen, 2015). It is vital to note that for the market to become efficient then the investors need to recognize the inefficiency in the market. Paradoxically, most of the investments that are aimed at taking advantage of the inefficiencies in the market are essentially vital in ensuring efficiency in the market (Damodaran, 2012).
A good example of market inefficiencies is that of a monopoly market. This is to mean that when a firm has dominant access to products or services, then the firm is able to control the prices and the distribution (Damodaran, 2012). This causes market inefficiency by the fact that the regular market forces are not able to determine and control prices in the market. In a case where there is a control and the marketplace is resourceful, then the contestants will arise and the monopoly will be required to adjust the prices in relation to the market constraints (Damodaran, 2012). This will cause a temporary inefficiency as a result of the monopoly and can give room for high profits.
The case of inflated goods is also an example of market inefficiency. When the market over values goods and products, then it means that there are increased prices (Pedersen, 2015). This mostly happens when the demand of a particular is high for a particular season and this causes the prizes to go higher. This market inefficiency is also temporary and as the demand recedes ten the market will allocate new prices for the same products (Pedersen, 2015).
It is vital to note that markets will never be perfectly efficient. One of the major causes of market inefficiency is the advancement in technology that has caused the market to be faster and more liquid (Mankiw, 2009). There are various sources of market externalities such as limitations like price floors and price ceilings. This prevents the prices from proficiently apportioning resources. The transaction expenses also greatly contribute to market inefficiency (Mankiw, 2009). For instance, if the costs of holding and keeping trade are very high then the market cannot be perfectly efficient. Other sources are the limited production of merit goods and the over production of demerit goods.
It is factual to understand that markets can never be entirely efficient or inefficient. In most cases we see markets that are a blend of both because not all information can be reflected in the stock markets on a daily basis (Damodaran, 2012). If the market was entirely efficient then the investors would seek to generate unusual proceeds and this would in turn cause the market to be inefficient. However, some off the internal and external externalities would be controlled in order to ensure that the market is efficient (Damodaran, 2012).
Conclusion
The government should seek to interfere with the market especially in cases where there is strong market inequality especially that which is caused by regulations. This is because it will seek to reduce the inefficiency by reducing restrictions and also ensure that there is universal market equity. They also aid in breaking monopolies which are a major cause of market inefficiency.
REFERENCES
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Mankiw, N. G. (2009). Principles of economics. Mason, OH: South-Western Cengage Learning.
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Pedersen, L. H. (2015). Efficiently inefficient: How smart money invests and market prices are determined.
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Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset. Hoboken, N.J: Wiley.
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