Understanding Market Failure
- 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, and enterprise)
- Free markets often work very well
- However, the free market sometimes leads to market failure, a situation where there is a less than optimal allocation of resources from the point of view of society
- For example, when the free market causes a lack of equity (inequality) or environmental degradation
- Market failure leads to either an over-provision or under-provision of the goods and services and therefore an over-allocation or under-allocation of the resources (factors of production) used to make these goods/services
- From society’s point of view, there is a lack of allocative efficiency