1.3.1
Types of Market Failure
Stuff you should know:
• Candidates should be able to:
• Define market failure
• Assess different types of market failure externalities, under-provision of public goods
and information gaps
What is market failure?
• Market failure occurs when the free market
(the price mechanism) causes an inefficient
allocation of resources.
• This leads to a loss in economic and social
welfare.
Why does a market failing lead to
inefficiency?
• There are two primary reasons for efficiency
occurring because of a market failure:
 Firms not maximising their output: their lost output from inefficient
production could’ve been used to satisfy more needs and wantscreating unemployed resources.
 Resources get misallocated and goods may be produced that aren’t
wanted, creating a surplus of goods which floods the market,
lowering the prices of the good in question. E.g. Ford Model T in
1929 leading up to the market crash.
 The triangle representing where
underproduction is taking place
Why might markets fail?
• Daniel J. Harris becoming Prime Minister.
• Externalities- negative or positive externalities
are the costs or benefits that affect third
parties.
• An under provision of public goods
• Imperfect market information