(i) Prevention of Market Failure

Market failure is a condition in which the market mechanism fails to allocate resources efficiently to maximize social welfare. Market failures occur in case of natural monopolies or asymmetric information, and in the presence of externalities.

♤ A natural monopoly occurs when an entire market is more efficiently served by one firm instead of two or more firms due to increasing returns to scale. Natural monopolies enjoy scale benefits that protect them from competition. When other firms enter, it leads to inefficient production because the average cost of input is much higher due to entry of multiple firms. For eg: In the transportation sector, Railways is a natural monopoly in India. As it makes sense for single entity to manage the sector as cost of setting up national network of rail lines would be very high.

♤ Asymmetric information is a situation where one party in a transaction knows more about the product than another. This prevents the market mechanism from achieving an efficient allocation of resources. This creates a role for regulation of market transactions by a third party to remove or minimize information asymmetries. In India, considerable information asymmetries exist in the health and education sector.

♤ Externalities may be positive or negative impact on the actors that are not directly linked to the concerned production or economic activity. For instance, an industrial plant discharging chemical waste imposes negative externalities on users downstream. Regulation, in such circumstances, is considered appropriate to restore economic efficiency. Putting ‘Pigovian Tax’ is one of such regulation. Ex – Clean Energy Cess.

(ii) To check anti-competitive practices Anti-competitive practices have implications for the economic growth and development of nations. Such practices restrict competition and deteriorate consumer welfare by creating entry barriers and price increases, that impedes to efficiency and innovation.

Firms may resort to anti-competitive practices such as price fixing, market sharing or abuse of dominant or monopoly power. Laws that empower officials to take action can help deter such practices. Regulation through a set of transparent, consistent, and non-discriminatory rules can create a competitive and dynamic environment in which all the market players can thrive and yield socially optimal outcomes.