: 1.9 Market Failure

What is market failure?

When the free market fails to allocate resources efficiently, leading to a loss of economic welfare.

What does allocative efficiency mean?

Resources are allocated efficiently when price equals marginal social cost (P = MSC).

What is the key cause of market failure?

When social costs and benefits differ from private costs and benefits.

What is an externality?

A cost or benefit to a third party not involved in a market transaction.

What is a negative externality?

When social costs are greater than private costs, leading to overproduction.

Give an example of a negative externality.

Pollution from factories causing health and environmental damage.

What is a positive externality?

When social benefits are greater than private benefits, leading to underconsumption.

Give an example of a positive externality.

Education, which benefits society through higher productivity and lower crime.

What are public goods?

: Goods that are non-rival and non-excludable.

What is non-rival?

One person’s consumption does not reduce availability for others.

: What is non-excludable?

: People cannot be prevented from using the good.

Why do public goods cause market failure?

The free-rider problem means firms cannot charge consumers, so goods are underprovided.

What is a merit good?

A good that is underconsumed in a free market but has positive external benefits.

Give two examples of merit goods.

: Education and healthcare.

What is a demerit good?

A good that is overconsumed and creates negative externalities.

Give two examples of demerit goods

Alcohol and cigarettes.

What is information failure?

When consumers or producers lack full or accurate information

: How does information failure cause market failure?

It leads to poor decisions and over- or under-consumption of goods.

What is market power?

When firms can influence price and output, such as monopolies.

Why does market power lead to market failure?

Firms restrict output and raise prices, causing allocative inefficiency and welfare loss.

What happens when social costs are higher than private costs?

Overproduction and allocative inefficiency.

What happens when social benefits are higher than private benefits?

Underconsumption and allocative inefficiency.