1.3.1 Types of market failure

Question 1

What is market failure?

Answer 1

Market Failure, where there is a less than optimum allocation of resources from the point of view of society. For example, when the free market causes a lack of equity (inequality) or environmental degradation. There is either over-provision or under-provision.

Question 2

What are the 3 main types of market failure?

Answer 2

/Externalities
/Information gaps
/Public goods

Question 3

Explain externalities?

Answer 3

Externalities occur when there is an external impact (cost or benefit) on a third party not involved in the economic transaction.

Question 4

Explain information gaps?

Answer 4

The reality is that in many markets buyers and sellers have different levels of information. This is called asymmetric information and distorts market prices and quantities.

Question 5

Explain public goods?

Answer 5

Public goods are beneficial to society but would be under-provided by a free market as there is less opportunity for sellers to make economic profits from providing these goods/services.