๐ญ The Factory and the River: A factory produces widgets cheaply and sells them profitably. Customers are happy; owners are happy. But the factory dumps waste in the river, poisoning fish, harming downstream farmers, and raising water treatment costs for the entire town. The factory's private calculation ignored these costs. The market produced "too many" widgets relative to what society truly wanted when all costs are counted.
๐ Externalities
Costs or benefits that spill over to third parties. Negative externalities (pollution) โ overproduction. Positive (education) โ underproduction.
๐๏ธ Public Goods
Non-excludable + non-rivalrous = free rider problem. Private firms can't profit from supplying them. Market provides zero โ government must supply.
โน๏ธ Information Failure
Asymmetric information: sellers know more than buyers (used cars, financial products). Leads to adverse selection and market distortions.
๐ Monopoly Power
Single firm restricts output to raise price above competitive level. Consumers pay more, get less. Deadweight welfare loss results.
| Type of Market Failure | Example | Government Response |
|---|---|---|
| Negative externality | COโ emissions | Carbon tax, cap-and-trade |
| Positive externality | Vaccination | Subsidies, mandates |
| Public good | National defence | Direct government provision |
| Information failure | Mis-sold insurance | Regulation, disclosure rules |
| Monopoly | Water companies | Competition law, price regulation |