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Market failure is a general term describing situations in which market outcomes are not Pareto efficient. Market failures provide a rationale for government intervention.

There are a number of sources of market failure. For the purposes of competition policy, the most relevant of these is the existence of market power, or the absence of perfect competition. However, there are other types of market failure which may justify regulation or public ownership. When individuals or firms impose costs or benefits on others for which the market assigns no price, then an externality exists. Negative externalities arise when an individual or firm does not bear the costs of the harm it imposes (pollution, for example). Positive externalities arise when an individual or firm provides benefits for which it is not compensated.

Finally, there are cases in which goods or services are not supplied by markets (or are supplied in insufficient quantities). This may arise because of the nature of the product, such as goods which have zero or low marginal costs and which it is difficult to exclude people from using (called public goods; for example, a lighthouse or national defence). It may also arise because of the nature of some markets, where risk is present (called incomplete markets; for example, certain types of medical insurance).

Source Publication:
Glossary of Industrial Organisation Economics and Competition Law, compiled by R. S. Khemani and D. M. Shapiro, commissioned by the Directorate for Financial, Fiscal and Enterprise Affairs, OECD, 1993.


Statistical Theme: Financial statistics

Created on Thursday, January 3, 2002

Last updated on Wednesday, January 4, 2006