1.3.1 - Types of market failure

When does market failure occur

When the price mechanism allocates goods and services inefficiently leading to a net welfare loss

Three different types of market failures

Externalities

Under provision of public goods

Information gaps

What are externalities

- profits and prices often do not represent the true cost of economic activities.

- There are often costs and benefits that affect the wider society

What are under provision of public goods

- Markets sometimes fail to provide certain goods

- Public good is a good or service provided without profit to all members of society

- eg: street lighting, policing

- They may be under provided by a free market because there is no incentive to pay for them

What are information gaps

When buyer does not have all necessary information to make an informed and rational decision

- Lack of information may lead to a decision that does not maximise utility

Excess supply diagram to show misallocation of resources

Excess demand diagram to show misallocation of resources