Market failure: the basics

In short: Market failure occurs when the free market alone does not lead to an efficient outcome, meaning resources are not used in the best possible way for the economy as a whole. Typical causes are externalities, public goods, market power and unequally distributed information.

In more detail: Market failure is regarded as an important argument for government intervention. At the same time, many economists point out that government measures can also fail, which is known as government failure.

In detail

• Efficiency as the yardstick: A market is considered efficient when nobody can be made better off without someone else being made worse off; market failure deviates from this.
• Externalities: When costs or benefits fall on uninvolved third parties, such as noise or air pollution, prices do not reflect all the consequences.
• Public goods: Because nobody can be excluded from using them, they are often undersupplied privately.
• Market power: Monopolies or cartels can push prices above the competitive level and reduce the quantity supplied.
• Information asymmetry: If one side of the market knows much more than the other, for example when buying a used car, markets can work poorly or collapse altogether.
• Possible interventions: These include taxes and levies, regulation, competition law, disclosure requirements or the public provision of goods.
• Government failure: Government measures can also be inefficient, for example due to missing information, misaligned incentives or the influence of interest groups.
• Weighing it up: Whether and how to intervene is often disputed and depends on the specific case and the expected costs and benefits (externalitaeten-grundlagen, monopol-oligopol-und-wettbewerb, oeffentliche-gueter-und-trittbrettfahrer).