Market Failure

Published Jan 2, 2023

Definition of Market Failure

Market failure is defined as a situation in which the free market fails to allocate resources efficiently. That means it occurs when the market does not produce the desired outcome, either because of an inefficient allocation of scarce resources or because of a lack of competition.

Example

To illustrate this, let’s look at the example of a monopoly. A monopoly is a company that has no competition and can thus set prices as it pleases (i.e., it has monopoly power). As a result, the monopoly can charge higher prices than they would (or could) in a competitive market. This leads to an inefficient allocation of resources because the monopolist can make more money by charging higher prices, which results in a deadweight loss.

Why Market Failures Matters

Market failure is an important concept in economics because it highlights the limitations of the free market system. It shows that the free market is not always the best way to allocate resources and that government intervention may be necessary in some cases. In some instances, the government may need to step in to regulate prices or break up monopolies in order to ensure a more efficient allocation of resources.

In addition to that, market failures can also lead to a decrease in economic growth and an increase in inequality, which is why it is important to understand and avoid them whenever possible.