Causes of market failure

Market failure is a term used by economists to describe the condition where the allocation of goods and services by a free market is not efficient. Market failure can be viewed as a scenario in which individuals' pursuit of self-interest leads to bad results for society as a whole. The first known use of the term by economists was in 1958, but the concept has been traced back to the Victorian philosopher Henry Sidgwick.

The belief that markets can have inefficient outcomes is a common mainstream justification for government intervention in free markets. Economists, especially micro economists, use many different models and theorems to analyze the causes of market failure, and possible means to correct such a failure when it occurs. Such analysis plays an important role in many types of public policy decisions and studies. However, not all economists believe that market failures occur, or that they are compelling arguments for government intervention, because some types of government policy interventions, such as taxes or subsidies, may lead to an inefficient allocation of resources, which has been called government failure.

Causes
In mainstream analysis, a market failure (relative to Pareto efficiency) can occur for three main reasons.

• First, an agent in a market can gain market power, allowing them to block other mutually beneficial gains from trade from occurring. This can lead to inefficiency due to imperfect competition, which can take many different forms, such as monopolies, monopsonies, cartels, or monopolistic competition, if the agent does not implement perfect price discrimination.
• Second, the actions of an agent can have externalities, which are innate to the methods of production, or other conditions important to the market.
• Finally, some markets can fail due to the nature of certain goods, or the nature of their exchange. For instance, goods can display the attributes of public goods or common-pool resources, while markets may have significant transaction costs, agency problems, or informational asymmetry. In general, all of these situations can produce inefficiency, and a resulting market failure.