Market failure occurs when the free market does not allocate resources efficiently. There are several sources of market failure, including lack of competition, externalities, public goods, and income inequality. Externalities happen when the actions of consumers or producers impose costs or benefits on third parties not involved in the market transaction. For example, pollution is a negative externality while vaccination programs provide positive externalities. Public goods are non-exclusive and non-rivalrous, meaning many can consume them without reducing availability. While controversial, government intervention through taxes, regulations, or direct provisioning can potentially correct for market failures.

1. Market Failure
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2. MARKET FAILURE
• Market failure means that the
market mechanism does not achieve
desirable results.
• Sources of market failure include lack
of competition (monopoly),
externalities, public goods, and income
inequality.
• Although controversial, government
intervention is a possible way to
correct market failure. 2

3. P
200 Monopoly and deadweight loss
175
150
MC (S)
125
100
75
50
25 MR D
1 2 3 4 5 6 Q 3

4. EXTERNALITIES
~ An externality is a cost or benefit of a good imposed
on people who are not buyers or sellers of that good.
~ Negative externality – external cost imposed to third
parties. E.g. Pollution, (too many resources are used to
produce the product responsible for the pollution) –
result in overproduction and underpricing.
~ Positive externality – external benefits enjoyed by
third parties. E.g. vaccination (too little resources are
allocated for the product) – result in underproduction
and underpricing.
~ Two basic approaches to solve this market failure are
taxes (like in pollution taxes) and regulation (like in
vaccinations). 4

5. External Cost of Pollution
Includes external costs of pollution
P2 S2 S1
P1
D
Excludes external costs of pollution
Q2 Q1
5

6. External Benefits of AIDS Vaccinations
Includes Vaccination benefits
S
P2
P1
D2
Excludes Vaccination benefits
D1
Q1 Q2 6

7. PUBLIC GOODS
• Public goods are goods that are consumed by
everyone regardless of whether they pay or not.
• Two properties of a public good: 1) Non-
exclusive; 2) Non-exhaustive
• e.g National defense, air traffic control, and
other public goods can benefit many
individuals simultaneously and are provided by
the government.
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8. Private goods vs. Public goods
• Consumption:
•Private good – only payers can consume
•Public good – nonpayers can still consume
• Supply – both production involve money cost and
opportunity cost
•Private good – production is profitable
(supplied by private firms)
•Public good – production not profitable
(provided by the govt or produced collectively)
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