Market failure

To understand a market failure it is imperative to define first a Pareto efficient allocation of goods. A market is said to be Pareto efficient if any reallocation of resources cannot make one person better off without making someone else worse off. A market failure is then a situation in which the trading of goods is not Pareto efficient. This in turn leads to a market where the quantity supplied does not equal the quantity demanded. The identification of market failures, i.e., the inefficient distribution of resources, often justifies public intervention aiming at Pareto-improving the market. There are various sources of market failures. The most common ones are externalities, the provision of public goods, lack of property rights, information asymmetry, market power, among others. Adapted from Durlauf & Blume (2016).