Analysis of Market Failure
Market Failure
Market failure occurs when the free market fails to allocated resources in an optimum and efficient manner. There are four main sources of market failure:
1) Externalities
Externalities occur when some of the costs or benefits associated with production or consumption of goods and services spill over onto third parties. When market failure is present, allocative efficiency is achieved when MSB=MSC
|Positive externalities |Negative externalities | |Occur when society benefits from the consumption or production of a |Occur when costs are imposed on society from the consumption or | |commodity or service |production of a commodity or service | |Education, vaccination etc. |Pollution, smoking etc. |
|Merit goods |Demerit goods | |Goods that society values and judges that everyone should have |Goods that society values and judges to be bad for and individual | |whether the individual wants them or not. | | |Underconsumed due to imperfect information – individuals are |Overconsumed due to imperfect information – individuals are unaware | |unaware of long-term benefits and positive externalities |of long-term detriments and negative externalities | |Consumption of merit goods is believed to generate positive |Consumption of demerit goods leads to a fall in social welfare (MPB | |externalities (MSB exceeds MPB) |exceeds MSB) | |Healthcare, education,
Market failure occurs when the free market fails to allocated resources in an optimum and efficient manner. There are four main sources of market failure:
1) Externalities
Externalities occur when some of the costs or benefits associated with production or consumption of goods and services spill over onto third parties. When market failure is present, allocative efficiency is achieved when MSB=MSC
|Positive externalities |Negative externalities | |Occur when society benefits from the consumption or production of a |Occur when costs are imposed on society from the consumption or | |commodity or service |production of a commodity or service | |Education, vaccination etc. |Pollution, smoking etc. |
|Merit goods |Demerit goods | |Goods that society values and judges that everyone should have |Goods that society values and judges to be bad for and individual | |whether the individual wants them or not. | | |Underconsumed due to imperfect information – individuals are |Overconsumed due to imperfect information – individuals are unaware | |unaware of long-term benefits and positive externalities |of long-term detriments and negative externalities | |Consumption of merit goods is believed to generate positive |Consumption of demerit goods leads to a fall in social welfare (MPB | |externalities (MSB exceeds MPB) |exceeds MSB) | |Healthcare, education,