Market Failure

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  • Created by: horlockm
  • Created on: 26-04-15 14:37

What the spec says we should know:

  • The Meaning of Market Failure
  • Public Goods
  • Positive and Negative Externalities in Consumption and Production
  • Merit and Demerit Goods
  • Monopoly and the Allocation of Resources
  • Immobility of Factors of Production
  • Inequalities in the Distribution of Income and Wealth

The meaning of market failure

A market fails when the price mechanism (i.e. the forces of supply and demand) fails to allocate scarce resources efficiently and society suffers as a result.

Market failure is a common problem and governments often intervene to prevent it.

When there's complete market failure no market exists- this is called a 'missing market'.

National defence is an example of a missing market as there's no market which allocates national defence. This means that governments need to intervene and provide it.

When the market functions, but either the price or quantity supplied of the good/service is wrong, the there is partial failure. 

The provision of health care, if left completely to market forces, is an example of partial failure. If health care was left to market forces, the some people wouldn't be able to afford the treatment they needed. As a result, governments might intervene and provide free health care.

Externalities are the effects that producing or consuming a good/service has on people who aren't involved in making, buying/selling and consumption of the good/service. These people are often called 'third parties'.

Externalities can either be positive or negative. Positive externalities are the external benefits to a third party and negative externalities are the external costs to a third party.

Externalities occur in:

  • Production
    • A negative externality of producing steel could be pollution that harms the local environment
    • A positive externality of producing military equipment could be an improvement in technology that benefits society
  • Consumption
    • A negative externality of consuming a chocolate bar could be litter that's dropped on the street
    • A positive externality of consumption could be the benefit to society of someone training to be a doctor

Externalities can be either external costs or external benefits:

  • A private cost of the cost of doing something to either a consumer or a firm. E.g. the cost a firm pays to make a good is its private cost and the price the consumer pays to buy the good is their pirivate cost
  • External costs are caused by externalities, e.g. if you dropped an empty crisp packet than that creates an external cost to the council who have to employ someone to sweep it up
  • Adding the private cost to the external cost gives the social cost. The social cost is the full cost borne to society of a good or service
  • A private benefit is the benefit gained by a consumer or a firm by doing something. E.g. the private benefit a consumer might get from purchasing a skiing holiday is their enjoyment of the experience
  • External benefits are also caused by externalities, e.g. a factory that invests in new equiptment may create the external benefit of needing less electricity
  • Adding the private


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