Market failure occurs when market forces of demand and supply are unsuccessful in allocating resources efficiently.
Key Terms in Market Failure
Social Cost: This is the true cost of consumption or production to society as a whole. This entails Private Cost & External Cost.( Private cost + External Cost)
Private Cost is the actual cost of production or consumption of a firm or individual, example are; cost of buying a car to drive, cost of acquiring machines for a firm, cost of acquiring a business.
External Costs are the cost borne by third parties during the process of production or consumption. they are the negative effects borne by those who are not involved either during consumption or production. Examples are: Neighbours do not receive payment for the noise they receive as a result of noise produced by the horn of a car, community members also don’t get treated for inhaling various fumes by a nearby factory.
Social Benefit: This is the true benefit of consumption or production. It entails Private Benefit & External Benefit (Private Benefit + External Benefit)
Private Benefits are the benefits of production or consumption experienced by an individual or a firm. Examples are: The profit made from running a business, the satisfaction derived from driving one’s car to an event.
External Benefits are the positive effects of production or consumption experienced by third parties for which no money is paid for. Examples are: A farmer who grows apple trees provides a benefit to a beekeeper. The beekeeper gets a good source of nectar to help make more honey, cycling to work will reduce pollution and will benefit everyone in the community.
Causes of Market Failure
- Abuse of monopoly.
- Factor Immobility.
- Lack of Public goods.
- Environmental degradation.
- Inequality of wealth distribution.
- Under provided Merit goods.
- Demerit Goods