16.3 Market Failures

The term market failure describes the failure of the market economy to
achieve an efficient allocation of resources. As we saw in Chapter 12
efficiency in the allocation of resources requires that price equal marginal
cost. If this equality exists in all industries simultaneously, we say that the
economy as a whole is allocatively efficient.

Market failure describes a situation in which the free market, in the absence of government

intervention, fails to achieve allocative efficiency.

It is useful at this point to recall the distinction between normative and
positive statements that we first encountered in Chapter 2. The
statement that the economy is allocatively efficient (or not) is a positive
statement. We can say that the economy has or has not achieved
allocative efficiency without making any value judgment—the statement
uses only an observation about economic outcomes and the definition of
allocative efficiency. Note, however, that the allocatively efficient
outcome may not be the most desirable outcome in a normative sense.
For example, an economy may be allocatively efficient even though the
distribution of income is judged by some to be undesirable. As we see
later in the chapter, such concerns provide another motivation for
government intervention.

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