Economics – The allocation of resources - Market failure | e-Consult
The allocation of resources - Market failure (1 questions)
Login to see all questions.
Click on a question to view the answer
Definition: Market failure occurs when the free market mechanism fails to allocate resources efficiently, resulting in a loss of economic welfare. This means that the market does not produce the optimal quantity of goods and services for society.
Causes of Market Failure (Two examples):
- Externalities: These occur when the production or consumption of a good or service affects a third party who is not involved in the transaction.
- Negative externalities (e.g., pollution from a factory) lead to a situation where the market price does not reflect the true social cost, resulting in overproduction.
- Positive externalities (e.g., education) lead to a situation where the market price does not reflect the true social benefit, resulting in underproduction.
- Public Goods: These are goods that are non-excludable (it's impossible to prevent people from consuming them) and non-rivalrous (one person's consumption doesn't diminish availability for others).
- Because of the free-rider problem (people benefit without paying), private firms are reluctant to produce public goods.
- This leads to underproduction of public goods, as the market mechanism alone cannot provide them efficiently.