What is Market Failure?

In economics, market failure is a situation in which the allocation of goods and services is not efficient. Efficiency in resource allocation implies what is desired by the society is produced and marketed at a price that reflect the cost of their production.

In the case of market failure, what is desirable for the society’s view point is not produced or the concerned goods are underpriced or overproduced. This is why market failure is interpreted as a case of misallocation of resources.

Market failure in the case of environment

An important example for market failure is the underpricing of some goods that causes heavy environmental degradation. Here, the market mechanism is not able to take all costs and benefits related to an economic activity in the price of the product. For example, in the case of sand mining from rivers, sand price doesn’t reflect the injury created to the river. Similarly, some of the fuel like diesel that contributed to pollution were given at a subsidized price in the past. As these goods are low priced compared to the cost incurred to the society, their consumption also goes up.

Market failure results due to self-interest driven consumption/production activities by individuals.

There are different situations that create market failure. Market failure can occur due to a variety of reasons, such as monopoly (price is high while production is low), negative externalities (commodity’s production creates adverse effect on others and it is over consumed) and subsidized/public goods (usually not reflecting the free market price).