Whenever a market leads to a misallocation of resources.
Misallocation of resouces
When resources are not allocated to the best interests of society.
Economic and social welfare is not maximised where there is market failure.
Types of market failure:
Externalities
Under-provision of public goods
Information gaps
Monopolies
Inequalities in the distribution of income and wealth
Externalities
The cost or benefit a third party receives from an economic transaction outside of the market mechanism. Negative: demerit goods; positive: merit goods.
The under-provision of public goods
Public goods are non-excludable and non-rival, and they are underprovided in a free market because of the free-rider problem.
Information gaps
Consumers rarely have perfect information; imperfect information leads to a misallocation of resouces.
Monopolies
Consumers have limited choice in where to buy the goods and services offered in a monopoly market, which is why the goods and servics are often overcharged. This leads to under-consumption, and therefore a misallocation of resources since consumer needs and wants are not fully met.
Complete market failure
When there is a missing market; there is no supply (of a good or service).
Partial market failure
The market produces the good at the wrong quantity or price, causing misallocation.
