What is a market failure and which of the following is a common example?

What is a market failure and which of the following is a common example?

• A. Market failure occurs whenever prices are high.
• B. Market failure occurs when there is full employment.
• C. Market failure is when markets allocate resources efficiently.
• D. Market failure occurs when markets fail to allocate resources efficiently; example: externalities like pollution or public goods.

Answer: (D)

Market failure happens when the price system alone doesn’t allocate resources efficiently. This shows up when actions by individuals or firms affect others in ways not reflected in prices (externalities) or when certain goods are hard to exclude people from using and don’t rival in consumption (public goods). Externalities, like pollution, impose costs on others without those costs being paid for in the market price, leading to overproduction of polluting activities. Public goods create a free‑rider problem, so they’re under-provided by markets because people can enjoy the benefits without paying. Because these situations prevent a socially optimal allocation of resources, market failure is described as a failure to allocate resources efficiently, with externalities and public goods as classic examples. The other statements don’t describe market failure correctly: prices being high doesn’t in itself signal a failure; full employment isn’t a marker of market failure; and market failure isn’t about markets allocating resources efficiently—that would be the opposite of failure.

Market failure happens when the price system alone doesn’t allocate resources efficiently. This shows up when actions by individuals or firms affect others in ways not reflected in prices (externalities) or when certain goods are hard to exclude people from using and don’t rival in consumption (public goods). Externalities, like pollution, impose costs on others without those costs being paid for in the market price, leading to overproduction of polluting activities. Public goods create a free‑rider problem, so they’re under-provided by markets because people can enjoy the benefits without paying. Because these situations prevent a socially optimal allocation of resources, market failure is described as a failure to allocate resources efficiently, with externalities and public goods as classic examples.

The other statements don’t describe market failure correctly: prices being high doesn’t in itself signal a failure; full employment isn’t a marker of market failure; and market failure isn’t about markets allocating resources efficiently—that would be the opposite of failure.