What is Market Failure?
- Market failure occurs when a market is not perfect.
- Resources are not allocated in an optimal manner.
- Community surplus is not maximized.
- This results in an allocative inefficiency where too much or too little of goods or services are produced and consumed from the point of view from what is socially the most desirable.
- As it can be considered the "job" of a free market to maximize community surplus and achieve allocative efficiency, if these are not achieved in a market, then it can be said that the market has failed.
- Keep in mind it is not considered market failure if the problem is caused solely by government intervention.
- Government intervention aims to solve or reduce the negative effects of market failure, but is rarely completely successful. In such cases, there is still market failure as the government just hasn't been able to solve it.
Reason for Market Failures
- Positive or negative consequences of consuming or producing certain goods are not included in the price of the goods.
- These are called externalities, and can be for example, environmental or social impacts.
Optimal Social Quantity
- A different type of graph can be used to understand market failure.
- These graphs function the same as demand and supply graphs, except the curves are split into two different curves: the private cost/benefit and the social cost/benefit.
- As we learned prior, both consumers and producers will aim to maximize their private utility and profits respectively.
- Therefore the market will allocate resources to meet private needs as efficiently as possible.
- However, the private benefits and costs do not necessarily reflect the benefits and costs of society that come from consuming and producing those goods have on society as a whole.
- If there is a discrepancy between the private benefits/costs and the social benefits/costs, then we can know that there is a market failure.
MPC - Marginal Private Costs
- The cost for firms to produce an additional unit of a good or service.
- Drawn in the same way as a supply curve.
MSC - Marginal Social Costs
- The total cost to society is when an additional unit of a good or service is produced . MSC includes MPC.
- Drawn in the same way as a supply curve.
MPB - Marginal Private Benefit
- The benefit to consumers of consuming an additional unit of a good or service.
- Drawn in the same way as a demand curve.
MSB - Marginal Social Benefit
- The total benefit to society when an additional unit of a good or service is consumed.
- Drawn in the same way as a demand curve.
Optimal Social Quantity
- The optimal social point is the intersection point for the MSC and MSB curves.
- It is the equilibrium when the supply curve includes MSC and the demand curve includes MSB.
- Supply and demand are labeled as S = MSC and D = MSB respectively.