Question

Explain three reasons for market failure and the ways government can intervene to deal with those instances of market failure

Answer 1

Market failure occurs when the price mechanism fails to account for all of the costs and benefits necessary to provide and consume a good. The market will fail by not supplying the socially optimal amount of the good.

3 Reasons for market failure are:

1)Negative externalities  impose cost on a third party, e.g. cancer from passive smoking.Government can deal with it by imposing tax on producer of negative externality.

2)Public goods are usually not provided in a free market.Government can provide these goods itself in order to solve this market failure e.g. national defence

3)Monopolist can charge higher prices and produce lower output.Government can solve this market failure by regulating the firm e.g. government can impose price ceiling on its products.

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