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Market distortion is a term used to describe a situation whereby there is some sort of disruption in the market that is the consequence of factors other than the normal effects of perfect competition. Usually, these distortions are the product of some governmental actions that serve the purpose of interrupting the normal flow of market forces. The market distortion may be created by the government for a specific reason; however, such a market distortion might result in a situation where there is a market failure in the affected economy. Some of the examples of tools utilized in the creation of a market distortion include the imposition of fees and levies on imports and exports, the creation of import quotas or export quotas, the creation of fixed prices, and the use of subsidies.
An example of a market distortion can be seen in a situation whereby a government of the country increases the import tariffs on certain products with various effects. The result of such a market distortion could be a sharp increase in the price of imported products, something that will be passed on to the consumers. AAnother way in which such a policy could affect the market could be in the form of an increase in underground markets as importers and consumers look for cheaper alternatives, even if these alternatives are derived from illegal activities like smuggling the goods into the country. For example, if the government were to increase the customs duties on imported chicken, such a policy might cause importers to look for other means of smuggling the chicken into the country. The same can also happen where there are import quotas limiting the amount of a specific item that can be imported into the country during a stated period.
Another factor that could lead to a market distortion is to use price control to create artificial conditions in the market. In such an instance, the purpose of the price control would be to set a price for stated products, something that is equivalent to interfering with the normal processes of demand and supply that happen naturally, creating a market distortion. For example, the government could set a maximum price for the sale of petroleum products by distributors, meaning that it has set a ceiling for the price of such a product, which distributors are not permitted to exceed.
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