1.3.1 Types of Market Failure

Market Failure

Market failure occurs when the allocation of resources in a free market results in an inefficient or socially undesirable outcome. It indicates that the market fails to achieve an optimal allocation of goods and services.

Externalities

Externalities are unintended side effects of economic activities that affect third parties who are not part of the transaction. They can be positive (benefits) or negative (costs).

Under-Provision of Public Goods

Public goods are non-excludable and non-rivalrous, meaning that no one can be excluded from their benefits, and consumption by one does not reduce availability to others. Because individuals can benefit without paying, there is a tendency for these goods to be underprovided by the private market.

Information Gaps (Asymmetric Information)

Information gaps arise when one party in a transaction has more or better information than the other party. This can lead to adverse selection and moral hazard problems.