Market Failure

• Market failure


  The inability of the market to allocate resources efficiently to best satisfy society's wants
• Causes of market failure

  • Existence of a monopoly
  • Merit goods
  • Public goods
  • Positive/negative externalities
• Public goods


  Goods that are collectively consumed by society, with characteristics of non-excludability and non-exhaustibility
• Public goods


  • Streetlights
  • Lighthouses
  • Police and defense
• Public goods

  • Non-excludability: customers cannot be excluded from consuming the good even if they did not pay for it
  • Non-exhaustibility: consumption of the good by one individual does not reduce the amount available for others
• Private markets cannot ensure that public goods are produced and consumed in the proper amount
• When a good does not have a price attached to it


  Private markets cannot ensure the good is produced and consumed in the proper amount
• Free rider


  A person who receives the benefit of a good but avoids paying for it
• The free rider problem prevents private markets from supplying public goods
• The government can decide to provide public goods if the total benefit exceeds the cost
• For economic efficiency, the price of a public good must be equal to its marginal cost, which is zero
• No firm will supply a public good at a price of zero, which is the implication of non-diminishability
• When there is market failure due to provision of public goods, the government intervenes and supplies the public goods, financed through taxation
• If a firm knows nobody is going to pay for a product but the firm will enjoy it, the firm will not supply it, leading to market failure
• The government intervenes and supplies public goods, financed through taxation, to address market failure caused by the lack of provision of public goods
• Public goods


  Goods where the social benefits to the community far outweigh the private benefits to the consumer
• Merit goods


  Goods where the social benefits to the community of the consumption of the good far outweighs the private benefit to the consumer
• Merit goods


  • Education
  • Health
• The government has to intervene to provide merit goods like public schools, public health centres, as private firms will not supply enough of these goods
• Externalities


  The spillover effects of production or consumption that falls on a third party
• Negative externalities lead markets to produce larger quantities than socially desirable, while positive externalities lead markets to produce larger quantities than socially desirable
• Positive externalities


  • Immunization
  • Restoration of historic buildings
  • Research into new technologies
• The government intervenes to address negative externalities, such as through taxes, to reduce production and pollution
• Monopolies cause market failure as the monopolist sells at a price greater than marginal cost, leading to too little of the good being produced at too high a price
• The government may intervene in monopoly markets to reduce market failure, such as by encouraging competition or regulating prices