Types of market failure — Edexcel A-Level Economics A
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Types of market failure explained
The specification identifies three types of market failure to understand.
Read the full explanation
Externalities are spillover effects on third parties not reflected in market prices: negative externalities, such as pollution from a factory, cause over-production relative to the social optimum, while positive externalities, such as vaccination protecting others, cause under-production. Under-provision of public goods arises because goods that are non-rival and non-excludable, such as national defence or street lighting, cannot easily be charged for; consumers have an incentive to free ride, so the market supplies too little or none. Information gaps occur when buyers or sellers lack the information needed for an efficient decision, as with a used-car buyer who cannot judge quality, leading to misallocation.
Your focus
- Identify and explain externalities as a type of market failure.
- Explain why public goods are under-provided by the market.
- Explain how information gaps lead to inefficient market outcomes.
Types of market failure exam tips
Marking Points
- Defines externalities as third-party spillover effects not reflected in market prices.
- Distinguishes negative externalities, causing over-production, from positive externalities, causing under-production.
- Explains public goods as non-rival and non-excludable, leading to free riding and under-provision.
- Explains information gaps as asymmetric or imperfect information causing inefficient decisions.
- Applies each type to a concrete example and states the direction of misallocation.
Examiner Tips
- 💡For each stem, name the type of market failure first, then justify it with the defining feature.
- 💡State the direction of misallocation explicitly: over-production, under-production or poor quality.
- 💡Use a one-line example to test whether the feature genuinely applies before selecting an option.
Common Mistakes
- Calling any external effect a negative externality; correction: positive externalities also exist and cause under-production.
- Describing public goods as simply goods provided by the government; correction: the defining features are non-rivalry and non-excludability.
- Treating an information gap as merely ignorance; correction: it is a market failure when missing information distorts the price or quantity traded.