Market failure is the situation where the free-market fails to allocate resources efficiently throughout the economy. As a result of the actions of self-interested individuals or firms in the market, there will be a negative impact on others, with some groups finding themselves worse off than before.
In free-market economics, it is assumed that when individuals and firms make rational self-interested decisions, the outcome will still be socially optimal for the rest of society. Market failure occurs when this is not the case.
The solution to most market failures is government intervention. The government will act in the economy to ensure that the failures of the market are solved and a socially optimal economy can pursued.
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Key terms:
Externality – a positive or negative spill-over affect on a third party after an economic transaction has taken place between two involved parties.
Factor immobility – where a resource is only able to be used for one purpose. If that purpose no longer exists, the resource no longer has any value.