® Market failure
By the end of this chapter, you should be able to:
0 describe the concept of market failure and explain the reasons for its occurrence
0 define private and social costs and benefits and discuss conflicts of interest in
relation to these costs and benefits in the short term and long term through
studies of the following issues:
O conserving resources versus using resources
o public expenditure versus private expenditure
Taken from Cambridge International Eminations Syllabus (IGCSE 045510 Level 2281)
O Cambridge International Examinations
Market failure
Market failure occurs when the produCtion or consumption of a good or service
causes additional positive or negative cxtcrlmlitics (spillover cffct‘ts) on a third party
not involved in the economic activity. In Other words, the market forces of demand
and supply fail to allocate resources efficiently.
Market failure may be caused by the ibllowing:
o Production of goods or services wh ich cause negative side-effecrs on a third party.
For example, the production ofoil or the construCtion of ofiices may cause damage
to the environment and a loss of green space.
0 Production ofgoods or services which cause a positive spillover efleCt on a third
party. An example is training programmes, such as firsr-aid or coaching skills for
employees, which create benefits that can be enjoyed by Others.
o Consumption of goods or services which cause a negative spillover effecr on a third
party. Such goods are known as demerit goods and include cigarettes, alcohol,
gambling and driving a car.
o Consumption of goods or services which cause a positive spillover effeCt on a third
party. Such goods are known as merit goods and include education, health care
and vaccinations.
0 Failure of the private sector to provide goods and services such as street lighting,
road signs and national defence due to a lack of a profit morive. Such goods and
services are known as public goods (see Chapter 15).
0 The existence of a firm in a monopoly market (see Chapter 13) that charges prices
which are too high and exploits custaners.
Private and social costs
The private costs of production and consumption are the actual costs of a firm,
individual or government. For example, the driver of a car pays for the insurance,
road tax, petrol and cost of purchasing the car. The ex ternal costs

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