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Market Failure

24 April, 2015 - 11:52

Learning Objectives

  • Explain what is meant by market failure and the conditions that may lead to it.
  • Distinguish between private goods and public goods and relate them to the free rider problem and the role of government.
  • Explain the concepts of external costs and benefits and the role of government intervention when they are present.
  • Explain why a common property resource is unlikely to be allocated efficiently in the marketplace.

Private decisions in the marketplace may not be consistent with the maximization of the net benefit of a particular activity. The failure of private decisions in the marketplace to achieve an efficient allocation of scarce resources is called market failure. Markets will not generate an efficient allocation of resources if they are not competitive or if property rights are not well defined and fully transferable. Either condition will mean that decision makers are not faced with the marginal benefits and costs of their choices.

Think about the drive that we had you take at the beginning of this chapter. You faced some, but not all, of the opportunity costs involved in that choice. In particular, your choice to go for a drive would increase air pollution and might increase traffic congestion. That means that, in weighing the marginal benefits and marginal costs of going for a drive, not all of the costs would be counted. As a result, the net benefit of the allocation of resources such as the air might not be maximized.