2. Meaning of market failure

When does market failure occur

When there is a misallocation of reasources

Complete market failure is when there is

A missing market

partial market failure is when

The market exists but contributes to resource misallocation

Examples of complete market failure

Public goods and infrastructure eg public parks, light houses, and national defence

why are public goods a cause of partial market failure

as they are non-excludable, consumers may be unwilling to pay for their full cost of production → free rider problem → private firms may be unwilling to invest in the production of these goods as they cannot capture the full value of their costs → provision becomes economically unviable → underproduction of these goods

resulting in an underprovision of goods that are socially desirable but not profitable for private firms to produce -. welfare loss and a suboptimal allocation of reasources

why are externalities a cause of market failure

the prices determined by the free market do not account for the external cost/benefit of these externalities leading to a net loss of social welfare

how do merit goods cause market failure

merit goods → underconsumed due to imperfect information and deemed socially beneficial → consumers comume where private benefit = cost as they only consider their own cost/beneft → socially optimum quantity is greater → welfate loss

How do demerit goods cause market failure

demerit goods → overconsumed due to imperfect information → their price does not take into account the negative external costs of consumption → externalities are not internalised into the price

why do monopolies lead to market failure

they limit efficiency, innovation, and healthy competition

deadweight loss

output is lower and price is higher than in a competetive market

why does inequality lead to partial market failure

In a market economy, an individual's ability to consume goods and services depends upon their income and wealth and an inequitable distribution of income and wealth is likely to lead to a misallocation of resources and hence market failure. Some consumers might not be able to buy goods and services at all

immobility of factors of production as a cause of market failure

eg geographical immobility of labour → not the most efficient use of reasources

supply cannot quickly change to adress changes in price

why does complete market failure occur

Markets often fail to provide public goods such as national defence or public parks because these goods are non-excludable and non-rivalrous. Private firms cannot profit from these goods leading to under provisions without government intervention.