Market Failure (Cambridge (CIE) A Level Economics): Revision Note

Understanding market failure

• Market failure occurs when the free market fails to allocate resources efficiently, meaning the quantity of goods produced does not maximise social welfare

• 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)

  • Free markets often work very well

• Market failure occurs when markets fail at delivering efficiency

  • Often, there is a less-than-optimum allocation of resources from the point of view of society

• There are several factors that cause markets to fail

• From society’s point of view, in each of these cases, there is a lack of efficiency in the allocation of resources

  • Sometimes there is an over-provision of goods or services which are harmful (demerit goods) and 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 or services which are beneficial (public goods and merit goods) and therefore an under-allocation of the resources (factors of production) used to make these goods or services e.g. education

  • In the case of common pool resources, there is an overuse of a finite resource