8.2 The Meaning of Market Failure

What is market failure

A misallocation of resources

What is complete market failure

When the market ceases to exist

What is partial market failure

When the market provides a good or service but in inefficient quantities or at inefficient prices

What are common causes of market failure

• public goods

• externalities

• asymmetric information

• monopoly power

• income inequality

Why do public goods lead to market failure

Public goods are non-rival and non-excludable, which causes the free rider problem, where people benefit without paying

Why do externalities cause market failure

Market fail to include social costs and benefits, leading to the overproduction of harmful goods and underproduction of beneficial goods, misallocating resources

How does asymmetric information lead to market failure

When one party knows more than the other in a transaction can lead to consumers making poor decisions, resulting in moral hazard and the production of lower quality goods or services

How does monopoly power lead to market failure

A monopoly has the power to reduce output or raise prices, leading to allocative and productive inefficiencies. Monopolies also might not prioritise allocating resources efficiently, as they can focus on gaining market share

Why does inequality cause market failure

Unequal distribution means some cannot afford essential goods, meaning there is an underproduction of necessary goods and services, leading to a misallocation of resources and increased social tensions.