Market failure happens when the market on its own does not give us the best outcome for society. In this lesson we’ll look at five main causes: public goods, merit goods, demerit goods, external costs & benefits, and monopoly abuse.
Definition: Goods that are non‑excludable (no one can be stopped from using them) and non‑rivalrous (one person’s use doesn’t reduce availability for others).
Example: Street lighting. Once the light is on, everyone can see, and one person using it doesn’t dim it for another.
Analogy: Think of a giant pizza that everyone can share. No one can be told “no, you can’t have a slice.”
Exam tip: Remember the two key characteristics: non‑excludable & non‑rivalrous. Use the acronym PNR (Public, Non‑excludable, Rivalrous).
Definition: Goods that society believes people should consume more of than the market would provide on its own.
Example: Vaccinations. The private market may under‑provide because people underestimate the benefits.
Analogy: A teacher giving extra homework to help students learn better, even though students might not want to do it.
Exam tip: Look for phrases like “under‑consumed” or “government should subsidise.”
Definition: Goods that are over‑consumed by the market because people don’t see the full cost.
Example: Cigarettes. The private cost is lower than the social cost because of health problems.
Analogy: A candy that tastes great but makes you feel sick later.
Exam tip: Identify “external costs” that the consumer ignores.
External Cost: Cost borne by someone other than the producer or consumer. Example: Pollution from a factory harming nearby residents.
External Benefit: Benefit enjoyed by someone other than the producer or consumer. Example: A well‑maintained garden improving neighbourhood aesthetics.
Analogy: If you spill paint on a wall, the wall owner suffers a cost you didn’t pay for.
Exam tip: Use the formula Social Cost = Private Cost + External Cost and Social Benefit = Private Benefit + External Benefit.
| Type | Example | Market Outcome | Corrected Outcome |
|---|---|---|---|
| External Cost | Factory pollution | Low production, high pollution | Tax or cap on emissions |
| External Benefit | Public park | Under‑funded | Government subsidy |
Definition: When a single firm dominates the market and can set prices above competitive levels, reducing output.
Analogy: A single ice‑cream shop in town that raises prices because no one else sells ice‑cream.
Exam tip: Look for “price‑setting” and “output restriction.” Use the formula \$P > MC\$ to show monopoly pricing.
📝 Exam Question Starter: “Explain how a monopoly can lead to market failure and suggest a policy to correct it.”
Answer outline: