Examples of Market Inefficiency
Warren Buffet said, “I’d be a bum on the street with a tin cup if the markets were efficient.” What he means is that he seeks underpriced stocks—ones that are worth more than the market thinks they are. Market inefficiency doesn’t apply only to stocks. If you become adept at recognizing inefficiencies in the marketplace, you can position your business to take advantage of those inefficiencies and prosper.
When the marketplace does not take all factors affecting price into account, the result is underpriced goods. This can work in your favor if you purchase raw materials or supplies for your business, and the seller does not price them as high as he could. However, if the market undervalues the goods you sell, you can find that you can’t set high enough prices to cover your expenses and provide a profit. This kind of market inefficiency tends to level out eventually, but you may find it difficult to raise prices until it does.
The market can overvalue goods. This can result in high prices for items you purchase for your business. It can, on the other hand, work in your favor if the market places a high value on the items you sell. You see this sort of phenomenon around the holidays, when certain toys command high prices because they are part of a craze. When everyone has to have it, your product can soar in price. This market inefficiency will not last forever. As demand ebbs, the market will assign a new value to your products.
When one company has exclusive access to a product or market, that company can control prices and distribution. This creates an inefficient market because normal market forces do not work to control prices. If you have a monopoly on a product, you will find that in an efficient market, competitors will arise and you will have to adjust your prices to market constraints. The temporary inefficiency that resulted from the monopoly, however, can provide you with big profits.
When no one is sure who owns the rights to a product, inefficiencies develop. This has occurred in the music industry, for example, where some consumers assume they have the right to free downloads of music, and the creators of the music claim they own the rights. The lack of clarity creates an inefficient market, where prices can go as low as zero.
Public goods are items the public needs but that the market does not find profitable enough to produce. Examples include roads, streetlights, park benches, flood prevention systems and libraries. The government tends to subsidize or pay for public goods. If your business provides products or services that contribute to public goods, you will profit from the market inefficiency produced by having only one customer—the government.