Overview

Markets don’t always allocate resources efficiently. Market failures—like externalities, public goods, and imperfect competition—justify government intervention. This topic explores how and when policy can correct market failures and the consequences of doing too much or too little.

Key Themes and Concepts

• Externalities:
  • Negative externalities: Costs imposed on others (e.g., pollution).
  • Positive externalities: Benefits to others (e.g., vaccines).
  • Remedies: Taxes, subsidies, regulation, property rights (Coase Theorem).
• Marginal Social Benefit (MSB) and Marginal Social Cost (MSC): Efficient outcomes occur when MSB = MSC. Market failure happens when private outcomes deviate from social efficiency.
• Public Goods:
  • Non-rival and non-excludable (e.g., national defense).
  • Free-rider problem: Individuals benefit without paying.
  • Provision: Governments provide or subsidize these goods.
• Private Goods: Rival and excludable — efficiently allocated through markets.
• Antitrust Policy: Promotes competition, prevents monopolies and collusion. Enforced through regulation and legal action.
• Regulation: Government rules to limit market power, improve safety, and correct failures. May lead to inefficiencies if poorly designed.
• Income Distribution:
  • Lorenz Curve: Visualizes inequality.
  • Gini Coefficient: Numerical measure (0 = perfect equality, 1 = total inequality).
  • Sources of inequality: Education, skill, discrimination, market outcomes.
• Public Policy Tools: Taxes, transfers, minimum wages, and in-kind benefits affect equity and efficiency.

Quick Tip

When markets fail, governments step in—but not always perfectly. Understanding externalities, public goods, and inequality helps explain when intervention is needed. The challenge is balancing efficiency with fairness while avoiding unintended consequences.