Several prerequisites must be fulfilled before perfect competition and free markets can work properly and generate the socially optimal output level. Several common problems include the following:

  • Externalities caused by incomplete or nonexistent property rights: Without full and complete property rights, markets are unable to take all the costs of production into account.

  • Asymmetric information: If a buyer or seller has private information that gives her an edge when negotiating a deal, the opposite party may be too suspicious for them to reach a mutually agreeable price. The market may collapse, with no trades being made.

  • Public goods: Some goods have to be provided by the government or philanthropists. Private firms can’t make money producing them because there’s no way to exclude non-payers from receiving the good.