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Understanding of market failure
Market failure occurs when the market fails to allocate scarce resources efficiently, economic and social welfare is not maximised.
Types of market failure
Externalities, the under-provision of public goods, information gaps
Type of market failure: Externalities
An externality is the cost or benefit a third party receives from an economic transaction outside of the market mechanism. Basically, the spillover effect of the production or consumption of a good or service
Type of market failure: The under-provision of public goods
Public goods are non-excludable and non-rival and they are under-provided in a free market because of the free-rider problem.
Types of market failure: Information gaps
It is assumed that consumers and producers have perfect information when making economic decisions. However, this rarely the case and this imperfect information leads to a misallocation of resources.