What is Market Failure?

• Market failure occurs when the free market fails to allocate resources efficiently

• This leads to a mismatch between what is produced and what society actually needs

Causes of Market Failure

1. Public Goods

Definition

Public goods are goods and services that the private sector does not provide due to a lack of profit motive.

Key Characteristics

• Non-excludable: People cannot be prevented from using them

• Non-rivalrous: One person’s use does not reduce availability for others

Examples

• Street lighting

• Road signs

• Law and order

• Flood control systems

• National defence

• Lighthouses

• Public roads

Why Market Failure Occurs

• The free rider problem: people can benefit without paying

• Firms cannot make profit, so they do not supply these goods

2. Merit Goods

Definition

Merit goods are goods that provide benefits to society but are under-consumed in a free market.

Key Concept

• They create positive externalities (benefits to third parties)

• Social benefits exceed private benefits

Examples

• Education

• Healthcare services

• Vaccinations

• Research and development

• Training schemes

• Public libraries

Why Market Failure Occurs

• Individuals underestimate the true benefits

• As a result, consumption is lower than the socially optimal level

3. Demerit Goods

Definition

Demerit goods are harmful goods that are over-consumed in a free market.

Examples

• Cigarettes

• Alcohol

• Fast food

Why Market Failure Occurs

• Consumers ignore long-term negative effects

• Leads to overconsumption

4. Monopoly Power

Definition

Occurs when a single firm dominates the market.

Why Market Failure Occurs

• Firms can charge higher prices

• Reduced competition leads to inefficiency

• Less innovation and choice

5. Factor Immobility

Definition

Factors of production (labour and capital) cannot move easily between industries or regions.

Why Market Failure Occurs

• Resources are not used efficiently

• Leads to unemployment and underproduction

Consequences of Market Failure

1. Misallocation of Resources

• Resources are not used where they are most needed

2. Welfare Loss

• Society loses potential benefits

• Either too much or too little of a good is produced

3. Social Problems

• Poor access to healthcare and education

• Lower productivity and living standards

4. Inequality

• Unequal access to essential goods and services

• Wider gap between rich and poor