Market failure and externalities
Market failure
- Market failure is when the market does not allocate resources efficiently — too much or too little is made.
- Then the government may step in.
Practice
Market failure occurs when:
Market failure means resources are misallocated — too much or too little of a good is produced.
Externalities
- An externality is a cost or benefit on a third party (not buyer or seller).
- negative externality (external cost, e.g. pollution): social cost > private cost → the market makes too much.
- positive externality (external benefit, e.g. vaccination): social benefit > private benefit → the market makes too little.
Practice
With a negative externality like pollution, the market tends to:
When external costs are ignored, social cost > private cost, so the market over-produces.
Practice
A positive externality (like vaccination) leads the market to under-produce.
Buyers ignore the benefit to others, so too little is produced compared with the social optimum.
You've got it
Key idea
- market failure = resources allocated inefficiently (too much/too little)
- a negative externality → over-production (social cost > private cost)
- a positive externality → under-production (social benefit > private benefit)