Market Failure: An Introduction

Market failure occurs when the allocation of resources by free markets results in an inefficient outcome, meaning that society is not getting the maximum benefit from available resources.

What Does Market Failure Mean?

In a perfectly competitive market, it is assumed that resources are allocated efficiently. However, real-world markets often deviate from this ideal, leading to situations where the market fails to achieve optimal resource allocation. This can result in:

• Loss of societal welfare
• Inequitable distribution of resources
• Environmental damage

Why Does Market Failure Occur?

Several factors can cause market failure. These include:

• Externalities
• Public Goods
• Information Asymmetry
• Market Power (Monopoly/Oligopoly)

Defining Market Failure

Market failure is a situation where the free market does not produce an efficient allocation of resources. This means that the quantity produced is not the socially optimal quantity, or the price is not reflecting the true social cost or benefit.

Types of Market Failure

Here's a breakdown of the key types of market failure:

Type of Market Failure	Description	Example
Externalities	Occur when the production or consumption of a good or service affects a third party who is not involved in the transaction. These effects can be positive (positive externalities) or negative (negative externalities).	Pollution from a factory (negative externality) or a government providing public health services (positive externality).
Public Goods	Goods that are non-excludable (it's impossible to prevent people from consuming them) and non-rivalrous (one person's consumption doesn't diminish the amount available for others). Free markets tend to under-provide public goods.	National defense, street lighting.
Information Asymmetry	Occurs when one party in a transaction has more or better information than the other. This can lead to inefficient outcomes.	The used car market, where the seller knows more about the car's condition than the buyer.
Market Power	Occurs when a single firm (monopoly) or a small number of firms (oligopoly) have significant control over the market price. This can lead to lower output and higher prices than in a competitive market.	A utility company with a monopoly over electricity supply.

Understanding the different types of market failure is crucial for evaluating the role of government intervention in the economy.

Further Reading

For a deeper understanding, refer to the textbook and additional resources provided by the teacher.