Course Content
Price System, Microeconomy: Consumer Theory
Price System, Microeconomy: Efficiency and market failure, Private costs and benefits, externalities and social costs and benefits
Price System, Microeconomy: Growth and survival of firms; Differing objectives and policies of firms
Macroeconomy: Economic growth and sustainability, Employment, Money and banking
CAIE Alevel Economics (A2)

definition of market failure

  • Market failure is a situation in which the free market fails to allocate goods and services efficiently, resulting in a suboptimal outcome.
  • In other words, market failure occurs when the market mechanism does not lead to the most efficient use of resources, and may result in a misallocation of resources, overproduction or underproduction.

reasons for market failure

  • Externalities
    • Externalities occur when the actions of one economic agent affect the welfare of others, either positively or negatively, without the corresponding compensation.
    • For example, pollution from a factory may harm the health of nearby residents without compensation, or a vaccine may reduce the spread of a disease and benefit the community as a whole without compensation.
    • Externalities can lead to inefficient outcomes, as the market may fail to take into account the full social costs or benefits of an activity.
  • Information failure, Provision of Merit and Demerit Goods
    • Information failure occurs when market participants have incomplete or inaccurate information about the goods or services being traded.
    • Merit goods are goods and services that are deemed to be socially desirable and under-provided by the market, such as education and healthcare, while demerit goods are goods and services that are deemed to be socially undesirable and over-provided by the market, such as cigarettes and alcohol.
    • The market may fail to provide an optimal amount of these goods due to externalities, imperfect information, or irrational behavior.
  • Provision of Public Goods
    • Public goods are goods and services that are non-excludable and non-rivalrous in consumption, such as national defense and street lighting.
    • These goods are typically provided by the government as the market may fail to provide them due to free-rider problems and the difficulty of excluding non-payers.
  • Adverse Selection and Moral Hazard
    • Adverse selection occurs when one party in a transaction has better information than the other party, leading to inefficient outcomes. For example, insurance companies may face adverse selection if only high-risk individuals purchase insurance.
    • Moral hazard occurs when one party has an incentive to take excessive risks or shirk their responsibilities due to incomplete contracts or insufficient monitoring. For example, a bank may take on excessive risk knowing that the government will bail it out in the event of a crisis.
  • Abuse of Market Power
    • Market power refers to the ability of a firm or group of firms to influence the price or quantity of a good or service in the market.
    • Abuse of market power occurs when firms use their market power to engage in anti-competitive behavior, such as price-fixing or exclusionary practices, leading to inefficient outcomes.
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