By Peter Antonioni, Manzur Rashid

Part of Microeconomics For Dummies Cheat Sheet, UK Edition

Understanding why markets fail is a key element in understanding microeconomics. Markets can fail for a number of different reasons, but the two most common are when a market provides something society doesn’t want, or doesn’t provide something society does want. Other reasons include the following:

  • Information: If consumers and producers do not have complete information then the problem is called asymmetric information. A lemon market — a market where there are lots of low quality products and you can’t tell before buying what the product quality is — is one example.

  • Too Few Property Rights: If no property rights are assigned then the good is called a common good and individuals will have an incentive to over-use it — as no one is paying for using it! The Tragedy of the Commons is an extreme example of this situation.

  • Too Many Property Rights: If a product depends on other things — for example earlier research — and there are property rights assigned to each of those things, then a market can fail because paying for the use of those properties is too high a fraction of total cost. This is called the Anti-Commons effect.

  • Public Goods: Public goods are not excludable, which means you can’t exclude anyone who hasn’t paid for the good — an example is street lighting. Markets find it hard to price these goods, so they tend to be produced collectively or through philanthropy

  • Externality: An externality is a cost or benefit that falls on a third party; for instance, if you buy land and build a factory but someone nearby is affected by your emissions.