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Market failure

Economics notes

Market failure

Market failure refers to a situation where the allocation of goods and services in a market economy is inefficient and fails to maximize societal welfare. It occurs when market forces of supply and demand do not lead to an optimal allocation of resources. Market failures can arise due to various reasons, including externalities, public goods, information asymmetry, market power, and natural monopolies. Externalities occur when the production or consumption of a good affects third parties who are not involved in the market transaction. Public goods, such as national defense or environmental protection, are undersupplied by the market due to the free-rider problem and non-excludability. Information asymmetry occurs when one party in a transaction has more information than the other, leading to suboptimal outcomes. Market power arises when a single seller or a few sellers have significant control over the market, resulting in higher prices and reduced competition. Natural monopolies occur when economies of scale make it more efficient for a single firm to provide a good or service. Market failures can have detrimental effects on efficiency, equity, and overall welfare. Understanding market failure helps in identifying areas where government intervention or policy measures may be necessary to correct the inefficiencies and improve societal outcomes.

What is market failure?

Market failure refers to a situation where the allocation of goods and services by a free market fails to achieve an efficient or socially desirable outcome. It occurs when market forces, such as supply and demand, lead to suboptimal results, such as underproduction or overproduction, externalities, imperfect information, or the presence of public goods.

What are the different types of market failure?

Market failure can occur due to externalities, public goods, imperfect competition, information asymmetry, and income inequality.

How does market failure impact economic efficiency?

Market failures lead to inefficient allocation of resources.

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