Understanding Market Failure
- In a free market, the price mechanism determines the most efficient allocation of scarce resources in response to the competing wants and needs in the marketplace
- Scarce resources are the factors of production (land, labour, capital, enterprise)
- Free markets often work very well
- However, the free market sometimes leads to 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 of the goods/services and therefore an over-allocation or under-allocation of the resources (factors of production) used to make these goods/services
- From society’s point of view there is a lack of allocative efficiency