Market failure

Market failure describes a situation where freely operating markets fail to allocate resources efficiently, leading to a loss in overall economic and social welfare. In a perfectly functioning market, the intersection of the demand and supply curves determines the equilibrium price and quantity. However, even at this equilibrium, the outcome may not reflect society’s best interests, and the market can produce too much or too little of a good. Market failure occurs whenever the market outcome does not meet societal needs, resulting in either overproduction or underproduction and a misallocation of resources. Market failures can arise from several distinct problems. A major type is a lack of competition, such as in monopolies, which can lead to higher prices and reduced output compared to perfectly competitive markets. Labour market failures occur when a single employer dominates hiring, resulting in lower wages and employment. Unstable commodity prices lead to inefficient investment decisions, as firms may commit resources based on prices that later fluctuate unpredictably. Each type results in a gap between private outcomes and what would be socially optimal, meaning resource allocation does not deliver the greatest benefit to society. Another significant source of market failure is externalities—costs or benefits that affect third parties not directly involved in the transaction. For instance, pollution from a factory may impose significant health costs on a nearby community, costs that the firm does not bear.