When does market failure occur?

Question

Markets create low prices for luxuries.

Markets create high prices for necessities.

Markets fail to reach an efficient outcome.

Markets fail to raise the wages of all workers above the poverty line.

Answer 1

Market failure occurs when the allocation of goods and services by a free market is not efficient. This can happen for several reasons, including:

1. Externalities: When the actions of individuals or businesses have effects on third parties that are not reflected in the market prices (e.g., pollution).

2. Public Goods: Markets may fail to efficiently provide goods that are non-excludable and non-rivalrous, like national defense or public parks.

3. Monopoly Power: When a single company or group controls a market, it can lead to higher prices and reduced output compared to competitive markets.

4. Information Asymmetry: When one party has more or better information than the other, it can lead to a misalignment in the market (e.g., in the case of used cars).

5. Inequality: If the distribution of income and wealth is highly unequal, markets might fail to achieve fairness and could be seen as failing to meet everyone's needs.

In your list, the most appropriate option that captures the essence of market failure is: "Markets fail to reach an efficient outcome." This indicates that resources are not allocated in a way that maximizes total welfare. While the other statements touch on concerns related to market outcomes and inequality, they do not directly define the concept of market failure.