What is market failure?

The term market failure describes the failure of the market system to allocate resources effectively. It takes place when the quantity of a product demanded by consumers is not equal to the quantity supplied by suppliers, meaning that the market fails to reach equilibrium. 

In order for resources to be allocated efficiently, the social marginal costs (SMC) should be equal to the social marginal benefits (SMB). 

Market failure can occur due to various reasons such as: 

- Immobility of labour: geographical and occupational immobility

  • Public goods: goods that are non-rival (consumption by an individual does not limit consumption by others) and non-excludable (cannot prevent anyone from consuming it) such as street lighting 
  • Asymmetric information: when there is lack of information by a party in a transaction 
    -Externalities:negative externalities (costs to third parties such as pollution) and positive externalities (benefits to third parties such as education can help the society)
    -Monopoly power: when a firm controls the market and is able to set high prices 
    -Commodity price instability
     

AH

Related Economics A Level answers

All answers ▸

What causes the aggregate demand curve to shift?


What is the basic economic problem?


Despite a plunge in the value of Sterling during 2016, the UK managed to post the highest current account deficit on record. Why did the plunge in sterling not translate into a reduction in the CA deficit?


How to define the term "external costs"