Introduction to Market Failure

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Market failure is an economic situation that is characterized by an insufficiency of goods and services in the market. In another perspective, market failure is defined as a situation in the market where each particular individual decides to make correct decisions in their own rights but eventually, those decisions turn out to be catastrophic for the survival of the whole group. A rather traditional approach as to what market failure is has been a state of imbalance that develops whenever the quantity that has been supplied in the market does not match up with the quantity that is being demanded. Market failure has been argued as the selfishness exhibited in the market. Market failures could happen for a number of reasons but the most common occurring them have been on the basis of public goods and externalities and this could be positive or negative.

Public goods refer to those goods in the market that is unrivaled and are non-excludable. This would, therefore, mean that these services and goods produced under the public goods tag cannot, therefore, be limited in consumption by the producer to the paying customers in the market. National policing and defense are some examples of public good and market failures would occur some consumers in the market exclude themselves from paying for public goods but still continue to enjoy the benefits. Like in the case of national defense, it's a common occurrence for all consumers to enjoy the same share of national defense despite their economic status quo as it is impossible to produce private military for each consumer. (Melberg, 2015)Public goods cause market failure s because most firms would definitely shy away from providing them as they are not a viable profitable option for them and then again, once the product is in the market, the firm real wouldn't be able to prevent these of that good by consumers. This is why the government is the primary provider of public goods and then voluntary organizations follow closely.

Positive externalities refer to those services and goods that accede a third party more benefits. For example, reducing congestion more so in our cities due to cycling would be considered as a positive externality in that particular situation. Externalities whether positive or negative do happen when the actions of one person to affect the wellbeing of another individual in the market. Positive externalities are therefore beneficial repercussions of one behavior in a free market. For example, if I were to clean our estate compound estate daily, my neighbor would definitely enjoy a clean environment where their kids can come out and enjoy (Caplan, n.d.).

Negative externalities are the complete opposite of what positive externalities are. While positive externalities bring about a positive effect, negative externalities have a foul effect of other players within the market. Negative externalities refer to services and goods whose provision in the market who arguably the third party to incur several costs because of that service. For example, provision of cigarettes in the market for the smokers has a ripple effect on passive smokers as they too are at health risk of getting cancer not because of their own actions but because of actions of another person with whom they share the market. The decision and actions in regards to the smoker will definitely affect even those that are not ascribed to smoking (Investopedia, 2018).

Graphically speaking, this particular diagram shows that when social costs are lower than the private costs then negative externality will likely occur. The equilibrium in the market is affected and that would definitely lead to negative or positive externalities.


Caplan, B. (n.d.). Externalities. Retrieved October 26, 2018, from Econlib:

Investopedia. (2018, February 13 ). How do externalities affect equilibrium and create market failure? Retrieved from Investopedia : -create-market-failure.asp

Melberg, H. (2015, June 13 ). What is the relationship between public goods and market failure? Retrieved from Quora:

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Introduction to Market Failure. (2019, Mar 18). Retrieved February 22, 2024 , from

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