Question

Which of the following is an example of a market failure?

Select one:

a. a rise in the price of oranges following a cold spell

b. an increase in wage rates causes suppliers to produce less of a particular good

c. a low-income individual cannot afford the cost of health insurance

d. a steel-producing factory pollutes a lake that a nearby community uses for fishing

Answer 1

The market failure occurs when there is an inefficient allocation of goods and services in the economy so the quantity demanded will not be matched by the quantity supplied or other wise. Simply the market will not be in a equilibrium position if there is a market failure , the market failure can happen due to various reasons such as externalities , in the case of public goods, monopoly concentration, merit goods , demerit goods etc....

In the cold spell there should be a decrease in the supply of a oranges that tend to increase the price of oranges , this is not a market failure. When there is a decrease in the supply the price would go up but the equilibrium will not be disturbed , a higher price with less quantity traded equilibrium would prevail in this case.

An increase in the wage rate directly contributes to the business cost so the increase in the cost will force the producers to decrease the production, so this either not a market failure. The equilibrium will be established at a higher price.

If the steel producing firm pollutes the river that is considered as a negative externality, the negative externality does lead to a market failure. A negative externality occurs when the production or a consumption activity inflicts an adverse affect on the third party. In this example the firm inflicts the adverse effect on the community who used to catch fish in the river. In this situation the social marginal cost is greater than the private cost so the equilibrium is disturbed here so there is market failure.

Ans: d. a steel-producing factory pollutes a lake that a nearby community uses for fishing.