Market failure

Market failure occurs when the free market fails to allocate resources efficiently, leading to a net welfare loss to society. In Edexcel A-Level Economics, this topic is central to understanding why governments intervene in markets. Market failure can arise from externalities, public goods, information asymmetries, and market power. For example, pollution from a factory imposes costs on third parties not reflected in the market price, resulting in overproduction of the good. Understanding market failure is crucial because it justifies government policies like taxes, subsidies, and regulation, which aim to correct inefficiencies and improve social welfare.

This topic builds on the concept of allocative efficiency (where price equals marginal social benefit) and productive efficiency. When markets fail, they produce either too much or too little of a good relative to the socially optimal level. Students must be able to identify different types of market failure, analyse their consequences using diagrams, and evaluate government responses. Market failure is a recurring theme across microeconomics, linking to topics like taxation, public goods, and competition policy. Mastery of this topic is essential for achieving top marks in essays and data response questions.

In the wider Edexcel syllabus, market failure appears in both Theme 1 (Introduction to Markets and Market Failure) and Theme 3 (Business Behaviour and the Labour Market). It also connects to macroeconomic objectives, such as environmental sustainability and income inequality. By studying market failure, students develop critical thinking about the role of government in a mixed economy. Real-world examples, such as carbon taxes to address climate change or the provision of street lighting as a public good, help illustrate these concepts. Ultimately, market failure provides a framework for evaluating economic policy and its impact on society.