Macroeconomics/Market Failure

Market failure happens when firms do not produce the quantity of output that would have been produced under the conditions of perfect competition. In other words, the quantity of output produced is either too little or too great. If it is too little then the product is under produced and under consumed. There is allocative inefficiency and society would be better off if more resources were used to produce the product. For example, under the conditions of imperfect competition, firms produce less output than they would produce under the conditions of perfect competition. If the quantity produced is too great, then the good is overproduced and overconsumed. Society would be better off if less output were produced and excess resources transferred to making another product that is in greater demand. An example of this type of market failure is the negative production externality.

Consumers who consume output without having to pay for it are known as free riders.

Causes of Market Failure

 * 1) Public goods - The main characteristic of public goods is non-excludability. This means that if the good or service is produced for one consumer, no other consumer can be prevented from consuming it. The classic examples are the service of a country's defense force, street lighting and lighthouses. For example, if I build a lighthouse so that my ships can be warned of a dangerous reef at night, there is nothing that I can do to prevent other people's ships from also enjoying the benefit of the light from the lighthouse. Can you see the problem that now arise? If ask other people to pay some costs of building the lighthouse, will they pay? Probably not. They will build the lighthouse anyway and that they will be able to consume the light for it. Consumers who behave in this way consume output without having to pay for it. Under produced by the market system. Too few consumers are prepared to pay for goods; they would rather be free riders. Therefore, there is an under-allocation of resources to the production of public goods and the market fail