Market Failures, Externalities and Public Goods

Microeconomics: Market Failures, Externalities and Public Goods

Market Failures

As productive and as efficient as our modern economy is we cannot meet all of our needs and all of our wants. This being the case, an certainly no one would expect perfection, there is clearly some failure on the part of the market to provide these goods and services. While the term failure may be a tad harsh, it is the essence of what has occurred… a market failure.

Market failure – The situation that exists when the market fails to function properly. Market failure occurs when the following condition exist:

  • When adequate competition does not exist. In an age where mergers are all too common, the result has been an increase in larger and fewer firms in many industries. In extreme cases, this results in a monopoly. The greatest threat that a monopoly poses is that it denies consumers the benefit of choice and competition. Because a monopoly occupies the top spot in its market, it can use its position to impede competition and restrict production. Thus in the end there are artificial shortages and higher prices. Inadequate competition may also enable a firm to influence politics by means of economic strength. In the past there have been executives who furthered the political careers of those closest to them. Though it is not necessary for a business to be a monopoly in order to influence politics, it certainly helps. A large corporation may simply want tax brakes on a state or local level. If the government refuses, then the plant may threaten to moves its facilities elsewhere. Because the government does not want an economic loss to its area, it may acquiesce to the demands of the corporation. In order to efficiently allocate resources, consumers, business people, and government officials must have adequate information about market conditions. Some of which is easy to obtain like sales prices or want ads. Yet there is a little more difficulty in ascertaining information about a companies earnings and dividends.
  • Buyers and sellers are not well informed. Without information uneducated decision are made. This leads to mistakes and thus, market failure.
  • Resources are not free to move from one industry to another. This is known as resource immobility. Resource immobility is a difficult problem in any economy. The efficient allocation of resources requires that land, labor, entrepreneurs, and capital be free to move to markets where returns are the highest. But there are times when a business that is located in a certain community decides to up and leave, leaving hundreds unemployed. The consequence of the move is a reason that may hamper the corporation from taking its business elsewhere. Resource mobility is considered ideal in the competitive market economy, but is actually much more difficult to accomplish. When resources are immobile, markets don’t function, as they should.
  • Prices do not reasonably reflect the costs of production. This represents a problem because then wealth is being redistributed unfairly and prices are too high.


Externality – an economic side effect that affects an uninvolved third party. These are also examples of market failures. There are two types of externalities:

  • Negative externality– harmful side effect that affects an uninvolved third party. In most events, it constitutes external cost.
  • Positive externality– beneficial side effect that affects an uninvolved third party.

    An externality, by definition, is an economic side effect that either benefits or harms a party not directly involved in the activity. A negative externality is an action that harms a third party resulting in external cost. An example of this would be the construction going on on the LIE. Because the roadway is being widened, trees along side have been taken down, thus exposing the once secluded service road and the homes that are alongside it. This construction has annoyed drivers, who have to put up with the mess and homeowners as well. A positive externality is if the economic action benefits a third party. Such an example can be drawn from the previously mentioned one. The construction on the LIE may cause traffic tie-ups, but local businesses may benefit from the traffic, which detours by their shops, and the workers who may require services from one of the businesses.

Public Goods

Public goods are those goods and services provided by the government because a market failure has occurred and the market has not provided them. Sometimes it is in our benefit to not allow for a market provision. In the case of police, national defense and public education it can be argued that private provision of these services would be less desirable for a variety of reasons.

Public goods are economic products that are consumed collectively, like highways, sanitation, schools, national defense, police and fire protection.

All members of society should theoretically benefit from the provision of public goods but the reality is that some need them more then others. For example the wealthy do not need welfare and the elderly still pay for school taxes. This leads to the inevitable argument about paying for public goods…. taxes!



COVID-19 and other Modern Lessons in Market Failures, Externalities and Public Goods


In the world of economics, the study of microeconomics delves into the intricacies of individual choices and interactions within markets. Three fundamental concepts within microeconomics—market failures, externalities, and public goods—continue to shape economic policy and discourse. These concepts hold profound relevance in our modern world, providing critical insights into contemporary challenges and opportunities. In this essay, we will explore these concepts and examine their applicability to real-world scenarios, offering thought-provoking insights into how they shape our economic landscape.

Market Failures: Imperfections in the Pursuit of Efficiency

Market failures represent situations where the market mechanism fails to allocate resources efficiently. One of the most striking modern lessons in market failures comes from the 2008 financial crisis. The housing market’s collapse triggered a cascading effect, highlighting the limitations of self-regulation in the financial sector. Risky lending practices, inadequate oversight, and the proliferation of complex financial instruments all contributed to the crisis. This event serves as a stark reminder that markets, left unchecked, can lead to systemic failures with far-reaching consequences.

Externalities: Recognizing the Unintended Consequences

Externalities occur when the actions of individuals or firms impose costs or benefits on others who are not involved in the transaction. In the modern context, environmental externalities, especially related to climate change, have taken center stage. The industrial revolution and subsequent waves of economic development have brought unparalleled prosperity but have also led to greenhouse gas emissions and environmental degradation. These negative externalities jeopardize the well-being of current and future generations, underscoring the urgency of addressing them.

Public Goods: Navigating the Commons

Public goods are characterized by non-excludability and non-rivalrous consumption, making them susceptible to under-provision by the private sector. The COVID-19 pandemic has offered a vivid contemporary example of the importance of public goods. Vaccines, which are global public goods, hold the potential to halt the spread of the virus and save lives. However, the equitable distribution of vaccines has been far from assured, reflecting the challenges of managing global commons.

Lessons for the Modern World

These concepts of market failures, externalities, and public goods offer essential lessons for navigating the complexities of the modern economic landscape. They underscore the limitations of laissez-faire approaches and highlight the vital role of government intervention and collective action. Several thought-provoking insights emerge:


In the realm of microeconomics, the concepts of market failures, externalities, and public goods serve as guiding lights that illuminate the path to a more equitable and sustainable future. The lessons drawn from these concepts resonate with the contemporary challenges and opportunities we face. As we navigate an increasingly interconnected world marked by complex global challenges, embracing these lessons is not only thought-provoking but also essential for shaping a better tomorrow.

Frequently Asked Questions about Modern Lessons to Market Failures, Externalities, and Public Goods

In the modern economy, market failures continue to be a topic of concern and study. Recent examples of market failures include the 2008 financial crisis and the challenges posed by income inequality.

The 2008 financial crisis serves as a stark reminder of how unchecked markets can lead to systemic failures. The collapse of the housing market triggered a global recession, highlighting the dangers of risky lending practices, inadequate financial oversight, and the proliferation of complex financial instruments. This crisis underscored the importance of regulation and the need to address market imperfections to prevent similar catastrophes.

Income inequality is another pressing issue that showcases market failures. Despite economic growth in many developed countries, income and wealth disparities persist. Modern economies have seen the benefits of globalization and technological advancement disproportionately favor certain segments of the population. This income inequality raises questions about the fairness and efficiency of market outcomes and calls for policies to promote more equitable distributions of wealth.

Understanding these recent examples of market failures sheds light on the imperfections that can exist within markets and underscores the importance of economic policy to mitigate their adverse effects.

Climate change is a compelling example of the concept of externalities in the modern world. It illustrates how the actions of individuals and firms can impose costs on society that are not accounted for in market transactions.

The burning of fossil fuels, industrial processes, and deforestation release greenhouse gases into the atmosphere, contributing to global warming and climate change. The negative consequences of these activities, such as rising sea levels, extreme weather events, and disruptions to ecosystems, extend beyond the parties directly involved in these activities. These are classic examples of negative externalities.

One of the challenges with climate change is that those responsible for emitting greenhouse gases often do not bear the full cost of their actions, while the broader society, and future generations in particular, suffer the consequences. This misalignment of incentives leads to insufficient efforts to reduce emissions, resulting in a tragedy of the commons.

Addressing climate change requires collective action, international cooperation, and policies such as carbon pricing, emissions reductions, and investments in renewable energy. The concept of externalities in the context of climate change underscores the need for innovative solutions and a global perspective to mitigate this global externality.

The COVID-19 pandemic has brought into sharp focus the critical role of public goods in modern society. Public goods are characterized by non-excludability and non-rivalrous consumption, and they are crucial for the well-being of communities and nations.

Vaccines are a prime example of a global public good during the pandemic. The equitable distribution of vaccines is essential to halting the spread of the virus and protecting public health worldwide. However, ensuring fair access to vaccines for all has been challenging, highlighting the complexities of managing global public goods.

Moreover, the pandemic has underscored the importance of a robust public health infrastructure as a public good. Healthcare systems, research institutions, and data-sharing networks are essential components of pandemic preparedness. Investments in public health infrastructure, as a public good, have proven critical in responding effectively to public health emergencies.

The COVID-19 pandemic serves as a stark reminder of the need for governments and international organizations to prioritize the provision and equitable distribution of public goods, especially in times of crisis.

Market failures, externalities, and public goods intersect in addressing environmental challenges such as climate change, offering insights into the complex nature of these issues.

Climate change exemplifies a market failure because the unregulated market fails to account for the external costs associated with greenhouse gas emissions. Firms and individuals often do not internalize the full environmental and societal costs of their actions. As a result, market forces alone are insufficient to reduce emissions to socially optimal levels.

Moreover, climate change presents a classic negative externality. The emissions from one entity contribute to a global problem that affects people and ecosystems worldwide. This underscores the need for collective action and international cooperation to address the externalities associated with climate change.

Public goods come into play when considering the global nature of climate change solutions. Climate stabilization is a global public good because the benefits of reduced emissions and a stable climate are non-excludable and non-rivalrous. Efforts to reduce emissions, transition to renewable energy, and develop climate-resilient infrastructure require coordinated action at both national and international levels.

In summary, market failures, externalities, and public goods intersect in the context of environmental challenges like climate change. These concepts highlight the limitations of market mechanisms, the necessity of addressing external costs, and the importance of global cooperation in providing and managing public goods for the benefit of current and future generations.