Market Failure (Copy)
2.10 Market Failure
2.10.1 Definition of Market Failure
- Market Failure = When the market system fails to allocate resources efficiently → leads to overproduction/underproduction of certain goods.
- Results in misallocation of resources.
- Key Idea: Free markets alone do not always achieve the best outcomes.
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Economics Full Scale Course
2.10.2 Causes of Market Failure
| Cause | Definition | Example |
|---|---|---|
| Public Goods | Goods that are non-excludable (cannot stop others using) and non-rival (one’s use doesn’t reduce availability). Free rider problem. | Streetlights, national defense |
| Merit Goods (under-consumed) | Goods with external benefits; people under-consume without govt support. | Education, healthcare, vaccination |
| Demerit Goods (over-consumed) | Goods with external costs; people over-consume without govt regulation. | Cigarettes, alcohol, drugs |
| External Costs (Negative Externalities) | Costs imposed on third parties not included in market price. | Pollution from factories |
| External Benefits (Positive Externalities) | Benefits to third parties not paid for by the consumer. | Public parks, vaccinations |
| Monopoly Power | Firms restrict output, charge high prices, reduce efficiency. | Local utility monopolies |
| Factor Immobility | Land, labour, capital not moving to where they are most needed. | Structural unemployment in declining industries |
2.10.3 Consequences of Market Failure
| Problem | Impact | Example |
|---|---|---|
| Over-consumption of demerit goods | Waste of resources + health/social problems | Smoking → healthcare burden |
| Under-consumption of merit goods | Missed social benefits | Lack of education lowers productivity |
| External costs ignored | Overproduction, pollution, harm to society | Factories dumping waste in rivers |
| External benefits ignored | Underproduction of socially useful goods | Too few vaccines taken |
| Monopoly abuse | High prices, less consumer choice | Internet providers exploiting lack of competition |
| Factor immobility | Unemployment, regional decline | Coal miners unable to shift to IT jobs |
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Economics Full Scale Course
Key Terms Summary
| Term | Definition |
|---|---|
| Public Good | Non-rival, non-excludable (streetlights) |
| Merit Good | Under-consumed, external benefits (education) |
| Demerit Good | Over-consumed, external costs (cigarettes) |
| Private Costs | Costs borne by producers/consumers directly |
| External Costs | Costs borne by third parties |
| Social Costs | Private costs + external costs |
| Private Benefits | Benefits enjoyed by direct consumer/producer |
| External Benefits | Benefits enjoyed by third parties |
| Social Benefits | Private benefits + external benefits |
Quick Exam Examples
- Public good: Streetlight → free rider problem → private firms won’t provide.
- Merit good: Vaccination under-consumed → govt subsidies or free provision.
- Demerit good: Cigarettes over-consumed → govt taxes to reduce use.
- External costs: Factory pollutes air → asthma in community.
- External benefits: Education → skilled workforce benefits entire society.
- Monopoly abuse: Firm raises electricity price unfairly.
- Factor immobility: Workers in rural areas unable to move to urban jobs.
Memory Hooks
- Market failure = inefficient allocation.
- Think P-MEDEF: Public goods, Merit goods, Externalities, Demerit goods, Monopoly, Factor immobility.
- Under-consumption: Merit goods, Positive externalities.
- Over-consumption: Demerit goods, Negative externalities.
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Economics Full Scale Course