Market Failure

[!def] Market failure
misallocation of resources

Misallocation: Where resources are not used to maximise society’s welfare

will happen if objectives of market participants conflict

Complete Market Failure

[!def]
There is no market available for a good which society regards as desirable

Output is 0

Partial Market Failure

[!def]
A market is available but the output cannot maximize social welfare

supply is higher/lower than demand

Monopoly

Monopolists seek to increase prices by restricting output
Less is produced than under a productively efficient, competitive market outcome

Lead to Market Failure

Private Costs&Benefits

direct costs to the producer/consumer for producing/buying the good or service
benefits of production and consumption enjoyed by a firm, individuals, or government.

Externality

[!def]
cost/benefit of production incurred by third parties which are not considered by individual economic agents

[!def] Imperfect Information
Economic agents may poorly estimate the private costs and benefits of a good

Merit goods

[!def]
goods that will create positive spillover effects in an economy
positive externality

A good which is underprovided in a market.

Social costs/benefits

Total social cost = private costs + external costs
Total social benefits = private benefits + external benefits

Economic use of resources

If Total social benefit > Total social cost
Economic welfare can be improved by encouraging more production and consumption.
If Total social benefit < Total social cost
Economic welfare can be improved by reducing production and consumption.

Private/Public Goods

Excludability

[!def]
The owners of a good have property rights which allows them to prevent others consuming their good

Rivalry

[!def]
Consumption of a good reduces the amount of the good that others can consume

Private goods: Excludability and Rivalry
Public goods: Non-Excludability and Non-Rivalry

The market provision of public goods is often prevented by free-riders
public goods are causes of market failure as

free-rider problem is a type of market failure that occurs when those who benefit from resources and public goods do not pay for them or under-pay.

Solution

[!def] State provision
when a nationalised industry is the main provider of a good or service