- "Market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value."
Market failures occur when the market fails to allocate resources efficiently. Public economics examines different forms of market failures such as externalities, public goods, and asymmetric information.
Externalities: Externalities occur when the production or consumption of a good or service affects the welfare of third parties who are not involved in the production process. Externalities can be positive (beneficial) or negative (harmful), and can lead to market inefficiencies.
Public Goods: Public goods are goods or services that are non-excludable (meaning everyone can benefit from them) and non-rivalrous (meaning one person's consumption of the good does not reduce the amount available to others). Public goods are often underprovided by the market, as it is difficult to charge individuals for the benefits they receive from the good.
Market Power: Market power refers to the ability of a firm to influence the market price of a good or service. When a firm has significant market power, it can raise prices above the competitive level and produce less output, leading to market inefficiencies.
Information Asymmetry: Information asymmetry occurs when one party in a transaction has more information than the other party. When this happens, the party with less information may make suboptimal decisions, leading to market inefficiencies.
Moral Hazard: Moral hazard is the tendency of individuals to take risks they would not normally take if they were fully responsible for the consequences of their actions. This can lead to market inefficiencies, as individuals may engage in riskier behavior when they know they will not bear the full cost of their actions.
Adverse Selection: Adverse selection occurs when one party in a transaction has more information than the other party about the quality of the good or service being exchanged. This can lead to market inefficiencies, as the party with less information may receive goods or services of lower quality than they expected.
Public Choice Theory: Public choice theory applies economic principles to political decision-making. It examines how politicians and government officials may pursue their own self-interest rather than the public interest, leading to market inefficiencies.
Government Failure: Government failure refers to situations where government intervention leads to unintended consequences or inefficient outcomes. This can occur when government policies are poorly designed, poorly implemented, or subject to rent-seeking behavior.
Market-Based Policy Instruments: Market-based policy instruments are policies that use market mechanisms (such as taxes, subsidies, or cap-and-trade systems) to address market failures. These policies can be more efficient than traditional command-and-control policies, but may also raise distributional concerns.
Behavioral Economics: Behavioral economics applies insights from psychology to economic decision-making. It examines how individuals make choices that may not always be rational, leading to market inefficiencies.
Externalities: This market failure occurs when the actions of one party in a transaction have unintended consequences for third parties who are not directly involved. For example, pollution from a factory may affect the health of nearby residents.
Asymmetric information: This market failure occurs when one party has more information than the other, resulting in an imbalance of power in a transaction. For example, a seller may have more information about the quality of a product than the buyer, which could lead to a transaction that is not in the buyer's best interest.
Public goods: This market failure occurs when goods or services that are beneficial to society as a whole are underprovided or not provided at all by the market. For example, national defense is a public good that could be underprovided by the market because it is difficult to exclude individuals from using it.
Merit goods: This market failure occurs when goods or services that are regarded as socially desirable are underprovided by the market. For example, education is a merit good because it is believed to improve the overall well-being of society, but some individuals may not be able to afford it.
Market power: This market failure occurs when a single buyer or seller has the ability to influence the market price. For example, a monopoly may be able to set a higher price than a competitive market would allow.
Income inequality: This market failure occurs when there is a significant gap between the incomes of different individuals or groups, which can lead to social unrest, reduced economic growth, and other negative consequences.
Behavioral economics: This market failure occurs when individuals do not always act in their best interests because of cognitive biases, emotion, or social pressure. For example, people may choose to smoke even though it is bad for their health because of addiction or social norms.
Natural monopolies: This market failure occurs when one firm can produce a good or service at a lower cost than any other firm can, which prevents new competitors from entering the market. For example, it may be more efficient to have only one power supplier in a geographic area.
Uncertainty: This market failure occurs when unforeseeable events or risks affect the market, such as natural disasters, technological breakthroughs or pandemics. The market cannot price them properly.
Tragedy of the Commons: This market failure occurs when common resources are overused or abused because no one has a specific property right over them. For example, overfishing of open seas or depletion of natural resources due to unsustainable grazing.
- "Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient – that can be improved upon from the societal point of view."
- "The first known use of the term by economists was in 1958."
- "Market failures are often associated with public goods, time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, or externalities."
- "The existence of a market failure is often the reason that self-regulatory organizations, governments or supra-national institutions intervene in a particular market."
- "Such analysis plays an important role in many types of public policy decisions and studies."
- "However, government policy interventions, such as taxes, subsidies, wage and price controls, and regulations, may also lead to an inefficient allocation of resources, sometimes called government failure."
- "Most mainstream economists believe that there are circumstances (like building codes or endangered species) in which it is possible for government or other organizations to improve the inefficient market outcome."
- "Several heterodox schools of thought disagree with this as a matter of ideology."
- "An ecological market failure exists when human activity in a market economy is exhausting critical non-renewable resources, disrupting fragile ecosystems, or overloading biospheric waste absorption capacities."
- "In none of these cases does the criterion of Pareto efficiency obtain."
- "It is critical to create checks on human activities that cause societal negative externalities."
- "Market failures are often associated with... information asymmetries."
- "Market failures are often associated with... principal–agent problems."
- "Market failures are often associated with... non-competitive markets."
- "Government policy interventions, such as taxes, subsidies, wage and price controls, and regulations, may also lead to an inefficient allocation of resources..."
- "Market failures are often associated with... time-inconsistent preferences."
- "Most mainstream economists believe that there are circumstances... in which it is possible for government or other organizations to improve the inefficient market outcome."
- "The concept has been traced back to the Victorian philosopher Henry Sidgwick."
- "Economists, especially microeconomists, are often concerned with the causes of market failure and possible means of correction."