Market failures

In economics, market failure is a situation in which the allocation of goods and services is not efficient. That is, there exists another conceivable outcome where an individual may be made better-off without making someone else worse-off. Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient – that can be improved upon from the societal point of view. The first known use of the term by economists was in 1958, but the concept has been traced back to the Victorian philosopher Henry Sidgwick.

Market failures are often associated with time-inconsistent preferences,information asymmetries,non-competitive markets, principal–agent problems, externalities, or public goods, thus existence of a market failure is often the reason that self-regulatory organizations, governments or supra-national institutions intervene in a particular market. Economists, especially microeconomists, are often concerned with the causes of market failure and possible means of correction. Such analysis plays an important role in many types of public policy decisions and studies. However, government policy interventions, such as taxes, subsidies, bailouts, wage and price controls, and regulations (including poorly implemented attempts to correct market failure), may also lead to an inefficient allocation of resources, sometimes called government failure.

Given the tension between, on the one hand, the undeniable costs to society caused by market failure, and on the other hand, the potential that attempts to mitigate these costs could lead to even greater costs from "government failure", there is sometimes a choice between imperfect outcomes, i.e. imperfect market outcomes with or without government interventions. But either way, if a market failure exists the outcome is not Pareto efficient. Most mainstream economists believe that there are circumstances (like building codes or endangered species) in which it is possible for government or other organizations to improve the inefficient market outcome. Several heterodox schools of thought disagree with this as a matter of principle.

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