1.3.1 Types of market failure

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.