Market Failure Defined
- In a free market, the price mechanism determines the most efficient allocation of scarce resources in response to the competing wants and needs in the marketplace
- Scarce resources are the factors of production (land, labour, capital, enterprise)
- Scarce resources are the factors of production (land, labour, capital, enterprise)
- Free markets often work very well
- However, there is sometimes a less than optimum allocation of resources from the point of view of society. This is called Market Failure
- Sometimes there is an over-provision of goods/services which are harmful (demerit goods) & therefore an over-allocation of the resources (factors of production) used to make these goods/services e.g. cigarettes
- Sometimes there is an under-provision of the goods/services which are beneficial (public goods & merit goods) & therefore an under-allocation of the resources (factors of production) used to make these goods/services e.g. schools
- Sometimes the market causes a lack of equity (inequality) - the rich get richer and the poor get relatively poorer
- Sometimes, environmental damage occurs during the production or consumption of a good/service
- In each of these cases, from society’s point of view there is a lack of efficiency in the allocation of resources