Question

Discuss the 3 forms of market failure?

Answer 1

Market failure happens when there is an inefficient allocation of goods and services in the free market. Furthermore, the individual incentives for rational behavior do not lead to rational outcomes for the group. The three forms are market faliue are:

1. Negative externality
   Negative externalities occur when production and/or consumption impose external costs on third parties outside of the market for which no appropriate compensation is paid. This causes social costs to exceed private costs. For an example:car drivers, who may fail to take into account the traffic congestion they create for others. Third-parties are individuals, organisations, or communities indirectly benefiting or suffering as a result of the actions of consumers and producers attempting to pursue their own self interest.
2. Monopoly Power
   Markets may be dominated by a single producer of the good or service, in which case a situation of monopoly exists.Having significant control over supply, firms in pursuit of maximum profits may attempt to make the market price higher than it would otherwise have been by restricting output. This abusive monopoly power can create market faliure.
3. Information Faliure
   Information failure is another, significant, market failure and can occur in two basic situations. Firstly, information failure exists when some, or all, of the participants in an economic exchange do not have perfect knowledge. Secondly, information failure exists when one participant in an economic exchange knows more than the other, a situation referred to as the problem of asymmetric, or unbalanced, information.? Information failure leads to make an informed choice.

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