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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:
- almost all types of taxes and subsidies, but especially excise or ad valorem taxes/subsidies,
- asymmetric information or uncertainty among market participants,
- 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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