Top Examples of Market Failure

Certain elements are necessary to create what economists refer to as “perfect competition”. When you have perfect competition, it means there are plenty of suppliers providing a variety of products to meet the demands of buyers or consumers. If one of these factors is weak or lacking, the market is classified as having imperfect competition. The factors aren’t missing, necessarily, they’re just weak or lacking. They’re not as strong as they should be. They don’t have the same weight as a perfect competition market.

When any of these factors or elements is missing, a market failure can occur. It doesn’t mean it will every time, it just makes it much more likely that market failure will occur if one of the important elements is missing. There are five major types of market failure that describe what crucial element would be missing in order to cause that market failure and keep it from being imperfect competition or, at the best, perfect competition.

Information Gaps

One reason you might have a market failure is that competition is inadequate. There aren’t enough suppliers providing competition for the buyers. If there is only one supplier, and they’re putting the cost too high, buyers aren’t going to buy it unless it’s something they absolutely need. If there is only one company providing a good, but they’re not making something that buyers want, then that’s also going to be a problem. If there is adequate competition, there are going to be a variety of products available at a variety of prices. If competition is inadequate, that will not be true, and it can lead to market failure.

None of these things is a definite “will lead to market failure” just with economists analyzing why markets fail. These are some of the main reasons that markets have failed. Next, we have “information is inadequate”. A good example of that is with cigarettes. If the cigarette companies didn’t tell people that smoking was bad, it could lead to lung cancer. It has lots of chemicals in it that were unhealthy for you. Whenever people found out that that information was inadequate, then they would stop buying it. On the same page, people that didn’t know smoking was bad would be buying the cigarettes, even though they didn’t have that information.

Once the information came out, there would be a sharp drop in sales where there was an inaccurate rise in sales before people knew all of the information. If all the information isn’t given about a product, then people may buy it ignorantly, not knowing that it’s bad for them. If people give information that is incorrect, then people may buy it not knowing that what they’ve been told is not actually true. So, having accurate, adequate information is going to keep you in a good market situation.

Resource Mobility

Inadequate information can lead to market failure. Next, we have “resources are not mobile”. If you are a supplier and you have resources, but you can’t get them to the places they need to be, then you’re not going to be making any money off of those resources. Some good examples are land. There are some places that needs land, but you can’t just transport land. For instance, England could use land, because they’re just on an island, and the United States has lots of open land. You can’t just take out a chunk of Wyoming and put it over on England and say, “Here, you’ve got land.” That resource is not mobile.

Another resource that could be mobile, but a lot of times isn’t, is people. Your labor forces. If you’ve got people that are willing to work for you here, but they’re not willing to travel and work for you in another place, that resource of human labor is not mobile. Having resources that are mobile, if you’re selling goods and products that can be shipped, then that’s going to be a good thing. If you’ve got resources that you can’t really move around, it’s not so good. If you’re trying to sell real estate, it’s got to stay in that one space; you can’t sell it and have it move somewhere else. You can’t move land to a different place. A lot of times, you can’t move a whole house to different places. Some houses you can, but it’s going to be a lot more expensive.

Negative Externalities

Resources that are not mobile can lead to market failure. Another element that could lead to market failure is negative externalities. These are side effects of a market that affect third parties. Externalities can be positive or negative. Positive externalities are not going to usually lead to market failure, where negative externalities can. Examples of negative externalities would be pollution. In the process of manufacturing goods you are producing a lot of air pollution. People aren’t going to be happy about that. The environmentalists that complain about it can lead to market failure for whatever market was polluting the air without any proper precautions.

Another example would be traffic. People buying new cars are going to be congesting areas with traffic. Lots and lots of cars on these highways are going to have traffic. It’s going to cause traffic jams at certain times of the day or certain days of the week. Traffic can be a negative externality. Yes, the car market is good. People need to buy cars. People need to get to work. However, whenever more and more people buy their own vehicles instead of carpooling or using public transit, those cars are going to all end up contributing to traffic congestion, which would be classified as a negative externality and can lead to market failure.

Public Goods

Lastly, we have “failure to provide public goods”. If you don’t provide something the public wants or needs, then you’re not going to have a very good market. People will have to actually want or need your product in order to go out and buy it. If you’re not providing something people actually want or need, then that could lead to market failure. Market failure is not always inevitable. You’ve got perfect competition, whenever all the elements you need are there. If one of those elements is weak, then you would have an imperfect competition. If one of those elements is missing, you could still have an imperfect competition. A lot of times, if you are missing one of the crucial elements for a perfect competition market, then you’re going to end up eventually heading into a market failure.

These five major elements that could contribute to market failure can contribute to market failure, but it will not always lead to market failure. If your business is experiencing one of these crucial elements that can lead to market failure, they will need to correct it or they most likely will experience a market failure.