Topic 6: Market Failure

 6.1 What is Market Failure?

• Occurs when the price mechanism doesn’t allocate resources efficiently.
• Leads to loss of economic and social welfare.
• Causes: externalities, public goods, merit/demerit goods, monopoly power, inequality, information failure.

 

6.2 Externalities

• Positive externality: benefits to third parties (e.g., vaccination, education).
• Negative externality: costs to third parties (e.g., pollution, smoking).
• Market ignores external costs/benefits → inefficient outcomes.
• Government fixes via taxes, subsidies, and regulation.

Memory cue: External = extra effects beyond buyer/seller.

 

6.3 Public Goods

• Non-excludable + non-rival (e.g., streetlights, defence).
• Free rider problem → people benefit without paying.
• Market fails to provide, so the government steps in.

 

6.4 Merit and Demerit Goods

• Merit goods: under-consumed due to imperfect information (education, healthcare).
• Demerit goods: over‑consumed due to imperfect information (junk food, smoking).
• Government provides/subsidises merit goods, restricts/taxes demerit goods.

 

6.5 Monopoly Power

• Firms with market dominance may exploit consumers (high prices, low output).
• Leads to allocative and productive inefficiency.
• Government regulates or promotes competition.

 

6.6 Inequality

• Market may create unequal distribution of income/wealth.
• Government intervenes via taxation, welfare, redistribution.

 

6.7 Information Failure

• Consumers/producers lack full or accurate info → poor decisions.
• Examples: misleading ads, hidden product risks.
• Government improves info via regulation, education, transparency