What is market failure?

Market failure refers to a situation in which the allocation of goods and services by a free market is not efficient. This typically occurs when the market does not achieve an optimal distribution of resources, leading to overproduction or underproduction of goods. In an efficient market, resources should be allocated in a way that maximizes total welfare, where consumer willingness to pay aligns with producers' costs. However, market failures can arise due to reasons like externalities, public goods, market power, and information asymmetries, which distort the true costs and benefits of economic transactions.

When market failure is present, it indicates that there are barriers to achieving efficiency, causing consumers or producers to face either too high or too low prices, or misallocation of resources overall. This ultimately results in a scenario where the needs and wants of society are not met to the fullest extent possible, making the identification of market failure crucial for policymakers aiming to improve economic outcomes.