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. A distortion is "any departure from the ideal of perfect competition that therefore interferes with economic agents maximizing social welfare when they maximize their own".[1] A proportional wage-income tax, for instance, is distortionary, whereas a
lump-sum tax is not. In a
competitive equilibrium, a proportional wage income tax discourages work.[2]
In
perfect competition with no externalities, there is zero distortion at market equilibrium of
supply and demand where
price equals
marginal cost for each firm and product. More generally, a measure of distortion is the deviation between the market price of a good and its
marginalsocial cost, that is, the difference between the
marginal rate of substitution in consumption and the
marginal rate of transformation in production. Such a deviation may result from government
regulation,
monopolytariffs and
import quotas, which in theory may give rise to
rent seeking. Other sources of distortions are uncorrected
externalities,[3] different tax rates on goods or income,[4]inflation,[5] and
incomplete information. Each of these may lead to a net loss in
social surplus.[6] Market distortions are events, decisions, or interventions taken by governments, companies, or other agents, often in order to influence the market. They are often the response on market failures, i.e., circumstances that prevent perfect competition and achieving an optimal equilibrium in the market.
In the context of markets, "perfect competition" means:
^•Louis Kaplow (2008). "optimal taxation," The New Palgrave Dictionary of Economics, 2nd Edition.
Abstract. • Louis Kaplow (2008). "income taxation and optimal policies," The New Palgrave Dictionary of Economics, 2nd Edition.
Abstract. • Alan J. Auerbach (2008). "taxation of corporate profits," The New Palgrave Dictionary of Economics, 2nd Edition.
Abstract.
^S. Rao Aiyagari, R. Anton Braun,
Zvi Eckstein (1998). "Transaction Services, Inflation, and Welfare," Journal of Political Economy, 106(6), pp.
1274-1301Archived May 21, 2005, at the
Wayback Machine (press +).