An Introduction to Market Failure (AQA A Level Economics)

Cause 

Public goods

• Public goods are beneficial to society but would be under-provided by a free market, e.g. flood defences

Externalities 

• Occur when there is an external impact on a third party not involved in the economic transaction between the buyer and seller, e.g. passive smoking, which is considered a negative externality
   
• These impacts can be positive or negative and are often referred to as spillover effects
  • These impacts can be on the production side of the market (producer supply) or on the consumption side of the market (consumer demand)

Tradegy of the commons 

• The tragedy of the commons occurs when common pool resources are used by either the producer or consumer in a way that is not sustainable
  • When left to the free market, there is no private ownership over these resources as it is costly and inefficient to find ways to exclude other producers 

Merit & demerit goods

• Merit goods are goods or services that are beneficial to consumer and society but the free market does not provide enough of them e.g. education or healthcare 
   
• Demerit goods are goods which have harmful impacts on consumers or society, e.g. cigarettes

Market imperfections 

• There are three types of market imperfections: imperfect information, monopoly/monopoly power and factor immoblity 
  
  • Imperfect information is when buyers and sellers have different levels of information in a market and this can distort market outcomes, resulting in market failure
  • Monopoly power causes market failures when a monopolist charges higher prices, which may lead to under consumption and reduced output, resulting in a partial market failure
  • Factor immobility is when factors of production are unlikely to be perfectly mobile
    • If they are immobile and cannot be easily reallocated to match a change in demand, markets will not clear, resulting in the misallocation of resources and partial market failure

Unequal distribution of income and wealth

• The unequal allocation of wealth or income can result in a misallocation of resources and market failure
  
  
• When wealth or income is not distributed in society, some consumers may not be able to afford to purchase goods and services
  • This could lead to poverty or increased negative externalities such as social unrest