Market failure is an economic phenomenon in which individuals in a group do not fare as well as they would under rational self-interest. In other words, they incur more costs than they receive, and so the prices of the group’s goods and services deviate from the ideal outcome – which is usually economically efficient. This problem is particularly pronounced in recessions, where the poorest are often the ones hardest hit by economic downturns.
In the 1970s, the concept of market failure helped justify the introduction of government-run production, social welfare programs, and market regulation. But it’s not clear whether these interventions are necessary or even desirable. Some economists argue that government intervention is unnecessary. Markets will correct themselves over time if they are allowed to function properly, and this can be achieved by government initiatives. The answer is a complicated one, and no single intervention is the best answer for every situation.
For example, second-hand car sales are a classic case of market failure. In some cases, customers don’t know the true history of the car they’re purchasing. Factors such as accidents or mileage affect the price. This leads to inefficiency in resource allocation because consumers cannot properly assess the true value of the goods and services that are being sold. And if a market fails to function properly, no business will supply the goods or services. As a result, the final price is too high, and the monopolist can restrict the supply of goods and services to maintain its high prices.
Another example of market failure is the discharge of agricultural chemicals into waterways without charging the costs to third parties. This means that the price of food won’t reflect the full societal costs of pollution. In other words, market failure occurs when private companies do not account for negative externalities – the costs they impose on third parties. Ultimately, this leads to a situation where the costs of agricultural chemicals are not adequately compensated by the benefits they provide to consumers.
The lack of public goods also leads to market failure. The cost of providing these goods is not proportional to the number of users. Furthermore, some of the goods are provided for free, which means that the cost to society does not rise. The government attempts to compensate for this by making it illegal for businesses to produce pollution. The government may attempt to eliminate negative externalities by introducing fines and restricting market activity. If these remedies do not work, they may turn to socialism.
The perfect-competition definition of the market also implies that the failure of the market is corrected by the intervention of the government. The competing consumers and entrepreneurs will always push the market toward equilibrium, but it may not reach it at any given time. This is because markets always have imperfect outcomes because of the limitations of human knowledge and the changing nature of real-world circumstances. Some economists propose interventions to correct market failures. For example, government intervention may result in tariffs or subsidies.
The common use of the term “market failure” justifies new government policies. While proponents of interventions love to point out that markets are imperfect, they often assume that government intervention will make them perfect. Academic economists have long questioned whether government intervention can maximize welfare. Moreover, measuring market outcomes by an unattainable ideal is not useful in the imperfect world. Instead, one should compare them to realistic alternatives. These are not only the results of economic activity, but also the consequences of them.
The concept of market failure is often used by policy proponents to justify tax increases on one or more products, but this is often misapplied. All goods have production processes that use water and chemicals, which have the potential to pollute the environment. By imposing taxes on one or two products, policymakers are reducing social welfare. But if the market fails to produce the national income that is necessary to sustain society, they are required to impose higher taxes.
A good example of a market failure would be a radio station that broadcasts to all listeners, and does not know who is actually listening to it or who has been paying for it. In this case, the government must provide the service, or subsidize the production of it by private enterprises. Alternatively, small groups of people can provide the public good with reasonable prices and payments. That would be a perfect example of public-good provision, although many commentators have misappropriated this concept.