7.3.5—Market failure

Market failure occurs when the market allocation of resources is inefficient, so the social benefits and costs of output are not correctly reflected in private decisions.

The result may be too much, too little or the wrong composition of output. Externalities, public goods, information gaps, market power and missing markets are common mechanisms; identify which one prevents the price system from coordinating resources.

If a factory’s pollution harms neighbours without appearing in its costs, the market can produce more than the socially efficient quantity.

Market failure does not mean the market produces zero output or that every government intervention improves welfare; compare the likely policy failure too.