Market Failure and Government Intervention

Market Failure

Occurs when the free market leads to an inefficient allocation of resources, causing a loss of economic and social welfare.

Types of Market Failure

Externalities, public goods, information gaps, and lack of competition.

Allocative Efficiency

Occurs when resources are distributed in a way that maximizes societal welfare.

Negative Externalities

Costs experienced by third parties due to an economic activity, which are not accounted for in the price of goods or services.

Example of a Negative Externality

Air pollution from factories affecting public health and the environment.

Marginal External Cost (MEC)

The additional cost imposed on third parties by producing or consuming one more unit of a good.

Government Solution for Negative Externalities

Taxes on polluting activities or goods, like a carbon tax.

Positive Externalities

Benefits to third parties from an economic activity that are not reflected in the price of goods or services.

Example of a Positive Externality

Education benefits society by creating a more skilled and productive workforce.

Marginal External Benefit (MEB)

The additional benefit received by third parties from producing or consuming one more unit of a good.

Characteristics of Public Goods

Non-excludability and non-rivalry.

Free-Rider Problem

Individuals benefit from public goods without paying, leading to under-provision of these goods.

Example of a Public Good

National defense or street lighting.

Quasi-Public Good

A good that has some characteristics of public goods but can be partially excludable or rivalrous, like toll roads.