What Is Market Failure?
Market failure, in economics, is a situation defined by an inefficient distribution of goods
and services in the free market. In an ideally functioning market, the forces of supply
and demand balance each other out, with a change in one side of the equation leading
to a change in price that maintains the market's equilibrium. In a market failure,
however, something interferes with this balance.
What Are Common Types of Market Failures?
Types of market failures include negative externalities, monopolies, inefficiencies in
production and allocation, incomplete information, and inequality.
Causes of Market Failure
1. Externalities: Externalities occur when the consumption of a good or service
benefits or harms a third party. Pollution resulting from the production of certain
goods is an example of a negative externality that can hurt individuals and
communities.
2. Information failure: If the buyer or seller in a transaction lacks access to the
information on which the price is based, they may be willing to overpay or
undercharge for a good or service, disrupting the market's equilibrium.
3. Market control: When one party has too much control over a market, this can
also create imbalanced pricing and lead to market failure.6 In the case of
a monopoly or oligopoly, a single seller or a small group of sellers can
manipulate pricing.
4. Public goods: Public goods and services are nonexcludable—once something
like a street light is produced, it is accessible to everyone, and the producer
cannot limit consumption only to paying customers. Public goods are also
nonrival, as use by one individual does not limit consumption by others. Given
these characteristics, the private sector has little incentive to produce public
goods, which leads to market failure, and the government usually must provide
these goods or subsidize their production.
How Can Market Failure Be Corrected?
The primary means by which market failure can be corrected is through government
intervention. This requires the government to pass legislation such as antitrust policies
(government policies to control monopolies) and to incorporate various price
mechanisms such as taxes and subsidies.
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