1.3.1 Types of market failure

Question 1

Explain why market failure exists

Answer 1

Market failure exists
when the competitive outcome of markets is not efficient (or equitable) from the point of view of the economy
as a whole i.e. resources are not allocated as efficiently as they could be. This is usually because the benefits
that the market confers on individuals or firms carrying out a particular activity diverge from the benefits to
society as a whole.

Question 2

When does complete market failure occur?

Answer 2

Complete market failure occurs when the market does not supply products at all – there is a missing market.

Question 3

When does partial market failure occur?

Answer 3

Partial market failure occurs when the market functions / exists, but it supplies either the wrong quantity of a
product or at the wrong price. Examples include negative externalities from
production, positive externalities from consumption, and information gaps.

Question 4

Why are property rights important?

Answer 4

Property rights confer legal control or ownership. For markets to operate efficiently, property rights must be
protected – perhaps through regulation. Put another way, if an asset is un-owned, no one has an incentive to
protect it from abuse. The right to own property is essential in a market-based system

Question 5

Explain what the Tragedy of the Commons is.

Answer 5

Failure to protect property rights may lead to what is known as the Tragedy of the Commons - examples
include the over use of common land and the long-term decline of fish stocks caused by over-fishing which
leads to long term permanent damage to the stock of natural resources. In this situation, individual users of
the asset (e.g. grazing land, the sea) aim to maximise their own utility, but in doing so, reduce the benefits for
everyone, and ultimately themselves, as the resource is over-used.