Market failure

Question 1

What is market failure?

Answer 1

When the free market fails to allocate resources efficiently, leading to a loss of economic and social welfare.

Question 2

What are the main types of market failure?

Answer 2

• Externalities
• Under-provision of public goods
• Information gaps

Question 3

What are externalities?

Answer 3

Costs or benefits to third parties (outside price mechanism) not reflected in market prices.
They can be:
• Negative (e.g. pollution)
• Positive (e.g. vaccinations)

Question 4

What is the under-provision of public goods?

Answer 4

Public goods (non-rival and non-excludable) are not provided by the market due to the free rider problem.

Question 5

What are information gaps, and how do they cause market failure?

Answer 5

Information gaps occur when buyers or sellers do not have full or accurate knowledge, preventing rational decision-making and causing market failure.

Question 6

What are the two types of information gaps

Answer 6

1. Asymmetric Information – where one party (e.g. seller) knows more than the other (e.g. buyer), leading to unfair outcomes (e.g. second-hand cars, insurance).
   
   2. Imperfect Information – where both parties lack sufficient knowledge, leading to poor choices (e.g. underestimating health risks of smoking).