Market failure
Market failure
- Market failure is when the price mechanism allocates resources inefficiently.
- External costs/benefits:
- private cost = cost to the doer; external cost = cost to others (pollution),
- social cost = private + external. Markets fail because firms ignore the external costs.
Practice
Social cost is equal to:
Social cost = private cost + external cost; markets fail because firms ignore the external part.
Merit, demerit & public goods
- merit goods (education, healthcare) — under-produced (better for you than you realise).
- demerit goods (cigarettes, alcohol) — over-produced.
- public goods (street lights, defence) — the market makes none, as firms can't charge for them.
- Monopoly power — one firm charges high prices, low quality.
Practice
The market makes no public goods (like street lights) because:
Public goods are non-excludable, so firms cannot charge — the government must provide them.
Practice
A merit good, like education, tends to be:
Merit goods are under-consumed; demerit goods (cigarettes) are over-consumed.
You've got it
Key idea
- market failure = inefficient allocation; social cost = private + external cost
- merit goods under-produced; demerit over-produced; public goods not made at all
- monopoly abuse is another market failure