Understanding Market Failure
Market failure occurs in microeconomics when free markets fail to allocate resources efficiently, leading to outcomes that do not maximize societal welfare. This happens due to imperfections like externalities, public goods, monopolies, and information asymmetries, resulting in deadweight losses and suboptimal equilibria.
Key Causes of Market Failure
Common causes include externalities, where actions impose unaccounted costs or benefits (e.g., pollution as a negative externality); public goods that are non-excludable and non-rivalrous, leading to free-rider problems; market power in monopolies that restrict output to raise prices; and asymmetric information, causing adverse selection or moral hazard.
Practical Example: Environmental Pollution
Consider a factory emitting pollution: without intervention, the firm ignores external health costs to nearby residents, overproducing goods and underestimating social costs. This negative externality exemplifies market failure, as the market price does not reflect true societal impact.
Role of Government Intervention
Governments intervene through policies like Pigouvian taxes on polluters to internalize externalities, subsidies for positive ones, direct provision of public goods (e.g., national defense), antitrust laws to curb monopolies, and regulations to ensure informed choices. These aim to restore efficiency, though they must balance intervention costs and potential government failures.