Definitions of Market Failure

 Market failure occurs when the forces of demand and supply do not ensure the
correct quantity of the goods and services produced to meet the demand at the
right time.
 Market failure is when the markets fail to achieve optimum resource allocation
 Market failure occurs when firms do not produce the quantity of output that would
have been produced under the conditions of perfect competitions
Causes of Market Failure
 When the efficient market requirements are not met, market failure occurs. We
consider each of these in turn
 Externalities
 Missing markets
 Imperfect competition
 Lack of information
 Immobility of the factors of production
 Imperfect distribution of income and wealth
Externalities
Externalities are the cost and benefits that convert private cost into social cost and
benefits –
This refers to a situation where the impact of a private economic activity impacts directly
on other economic agents that are/were not directly involved –
Externalities are also known as spill-over or third-party effects.
- Example: chemical factories

 Benefits - employment
 Cause - air pollution, industrial waste, acid rain
Missing Markets
Markets are often incomplete in that they cannot meet the demand for certain goods,
namely

 Community goods ( defense, street lights, police)

 Collective goods are free for everyone to use because of non-rivalry and non-
excludability (ex. parks, roads, public transport, sewerage system)

- Community goods and collective goods together known as Public goods

Non-rivalry in consumption
-If I consume more, others do not need to consume less
Non-excludability
- you cannot prevent people from consuming the goods
- free-rider problem

Missing Markets
• Merit goods benefit society and increase its welfare.
Missing Markets
• Demerit goods
• - are harmful to society and such goods would be over-consumed in the
free market

Government Intervention
• Government to produce public goods and services themselves
• Community goods and services to be provided free of charge
• Some collective goods are provided for a user fee
• Provision of some collective goods is subsidized
• Charge sin tax (excise tax) on demerit goods
• Ban the consumption of demerit goods
• provide information on the harmful effects of demerit goods
Imperfect Markets
• It is the common type of market structure due to
￭ Exclusive control of the factors of production
￭ Having the patents or copyright
￭ Firms network in the market to create economic scales
Types of Imperfect market
• is the market structure where the firms that operate in the market have a
lot of control over the goods or services they produce.
• This happened when the number of firms that produced the goods or
supply certain services is very few in the market
• This allows them to restrict output, raise price exceeds marginal cost.
Government Intervention
• Encourage competitions abroad
• Taxing the firm economic profit

Lack of information/Asymmetric information

- When the participant in the market do not have perfect information, production, and
consumption decisions may be skewed.
• Consumers -to maximize their benefits, consumers needed to detailed
information about goods and services, advanced technologies offer this
• Workers - are often unaware of job opportunities
• Entrepreneurs - lack of information on cost, availability, and productivity of
factors of production impact their effectiveness

Government Intervention
• Government can require firms to disclose information about their
operations so that their shareholders have better information.
• Firms are required to disclose information about their products (ex.
ingredients)
• Have a body that deals with misleading and unethical advertising
Immobility of Factors of Production
- Most markets do not adjust rapidly to changes in supply and demand
- In real life, factors of production are not free to move from one sector to another.
• Labour -takes time to move between occupation and geographical areas.
• Physical capital - factory building and infrastructure
• technological change - firms take time to adapt to new technologies (ex.
Introduction to robots to replace labor)
Government Intervention
• Introduce policy to deal with skills mismatch and regional mismatch
• Expand the system of Education to increase the literacy rate
• Improve labor mobility through transport and accommodation subsidies

Imperfect Distribution of Income and Wealth

- In the real world, there is an unequal distribution of wealth and income due to:
• Differences in occupation - wages and salaries of professions differ
• Differences in skills - people are not born with the same abilities
• Differences in experiences - people with more experience often get high
salaries.
Under these circumstances, the market fails to ensure that everyone in the society gets
equal access to the output of the economy.
Government Intervention
• A progressive system of taxation is used
• Benefits in kind to people that are less well-off (pensions, child support
grants, disability grants)
• Subsidies to reduce the costs of basic goods and services