Why do markets fail?

In competitive markets, the free market mechanism is in most cases the most efficient. However sometimes, these markets fail indicating a requirement for government intervention. The most famous example is that of adverse selection in the second-hand car market- where adverse selection is a process that affects market participation via information asymmetry: buyers and sellers have differing information about the products in the market.

Suppose you want to buy a second hand car and you know that the car will either be high quality or low quality but you don't know what cars on the lot are which. You will assume that some are good and some are bad, and the amount you are willing to pay will be an average of the two. Your AVERAGE w-t-p will be higher than your w-t-p for a low quality car but lower than your w-t-p for a high quality car. When the market is in eqm, the seller will be willing to sell a good quality car at your w-t-p for high quality and vice verse. However, your average w-t-p is what you offer for a car as you don't know which is which. This means the seller will sell you a bad quality car as P(av)>P(low). Eventually, sellers will run out of bad quality cars and are unwilling to sell a good quality car at the assumed market price (Pav) so will leave the market. The average quality of cars will fall, thus you revise your average w-t-p downwards, causing high quality to leave the market further, and this continues happening -Eventually a new eqm is reached where no trade occurs and the market has 'collapsed'.