Market Failure Problems and How to Overcome Their

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Market failure and its solutions. This paper concludes the factors those are responsible for market failure. In addition, the results of this study reveals ten variables to overcome the market-failure problems. The conceptual framework has been developed by finding and evaluating the factors of market failure and factors (solutions) of overcoming market-failure problems.

A qualitative method was applied to achieve the study objectives. The results also show that how the free-market economy can reach to the market equilibrium position from the market disequilibrium condition. Thus, the recommendations of this research are helpful for home govt. and Businessman to keep the open market in equilibrium position.

Keywords: Market Failure, Market Equilibrium, Market Disequilibrium, Overcoming Market Failure, Free-Market Economy.


Present as well new market in the business may face some challenges and in some cases market may fail for some general cases. Market failure is the state in which equilibrium condition does not exist. Equilibrium is a situation in the market where both buyers and sellers are agreed to exchange a required quantity of goods at an agreed price. It is a point of rest (Extra / additional one) where a consumer is supposed to have attained maximum satisfaction, and an entrepreneur has reached maximum profit.

Market failure is the mostly results of ignorance of the consumer, ignorance of the consumer, natural monopolies, absence of relevant information, allocation of resources in times of emergencies, speculation, inequalities in the distribution of income and wealth, restrictions on imports, optimization of the rate of savings, provision of humanitarian services and so on. Traditional reasons for market failure that have particular relevance to energy efficiency include public goods, externalities, decreasing-cost industries, and institutional barriers to the transmission of clear prices signals. Other studies show that causes of market failures include collective property resource management, non-competitive markets, and the assignment and defense of property rights.

In the following assumed figure point “E” refers to the Market equilibrium position refers to the equilibrium price and equilibrium quantity match in the area where the demand curve and supply curve intersect.

Objectives Of The Study

The primary purpose of this research is to evaluate and determine the reasons for market failure and make some accomplishment and solutions to overcome this problem.
The specific objectives of this study are:
To identify the compelling reasons for market failure.
To develop the theoretical framework for market failure and recovery.
To provide some recommendations and solutions to overcome market failure.

Research Methodology

The descriptive research design has used for conducting the research process. It is a literature review based research paper. Secondary data has been used to develop a conceptual framework. Secondary data have been collected from various related books, journals, and articles and mostly from the websites.

Market Failure

To know about market failure, the term Market ‘Disequilibrium’ is needed to know first. Here Disequilibrium is a situation where internal or external factors confine market equilibrium from being reached or cause the market to fall out of the balance. This can be happened by a short-term byproduct of a change in variable factors or a result of long-term structural imbalances.

A market in equilibrium is said to be operating efficiently where the quantity supplied equals to its quantity demanded at an equilibrium price showed in the graph where the line Pe and line Qe amalgamate each other. In any equilibrium situation, there are neither surpluses nor shortages. In the above diagram, the price at Pe is the single price at Qe quantity in where the farmers and consumers were engage to exchange. The intersection point of Pe and Qe refers the balance of supply and demand of product. But above or below the Pe point and forward or backward the point Qe will make surplus or shortage of supply and demand.

Market Failure- This occurs when there is an inefficient allocation of resources in a free market. Market failure can occur due to a variety of reasons, such as monopoly (higher prices and less output), negative externalities (over-consumed) and public goods (usually not provided in a free market)

Market failure occurs when the price mechanism fails to account for all of the costs and benefits necessary to produce and consume a good. Market failure occurs when the price mechanism fails to account for all of the costs and benefits required to produce and consume a goods. The market will fail by not supplying the socially optimal amount of goods. Market failure occurs due to inefficiency in the allocation of goods and services. A price mechanism fails; it will be over or under-produced .

Inefficient allocation of goods and services in an economy are the main reason for Market failure. From the various causes for market failures, a monopolistic structure and negative externalities are the vital reasons. Subject of market failure comes to light when the competitive outcome of markets is not satisfactory (value judgments) for the society. Mostly market failure is Complete and partial market failure. Complete market failure- When the market does not supply products at all according to the market demand . Partial market failure- When the market produces either the wrong quantity of a product or at the incorrect price although the does function well.

Example of Market failure- Monopoly privileges leads to market failures when the goods produced are not consumed by consumers for high prices or when they fail to meet consumer expectations. Market failure may arise when the market is a monopoly where a single producer or group of producers control the market by deciding the price of the commodity what they produced named price setters. .
So in a nutshell market Failure is the condition where the economy did not meet the needs of consumers or benefit society in the highest degree.

Reasons Of Market Failure

No market is perfect due to the market structure, and this occurs when an inefficient allocation of resources in a free market. Market failure can occur owing to various reasons, mainly including- Presence of public goods, Lack of public goods, Presence of Merit and Demerit goods-, Underproduction of merit goods, Overprovision of demerit goods, Presences of Monopoly Business, Presence of externality, Lack of information, Lack of property right, Carrot and stick policy, Unnecessary Government intervention, Factor Immobility and environmental concern.

  • Presence of public goods

Public goods are those usually supplied by the government at a free of cost, and total cost of production does not increase with the number of consumers. Therefore consumers are a free rider. On the other hand goods or services, those have to be purchased called private products. The general tendency is that when two goods exist simultaneously; someone gets to benefit from resources or products and services without paying for the cost of the interest – is known as the free-rider problem and by this way demand for public products is higher than private Products. This imbalance leads to market failure.

  • Presence of Merit and Demerit goods

Merit goods are those which are beneficial to the society (school, hospital, church, etc.). On the other, hand demerits goods are those that are harmful to community. Historically it is proved that demerit goods are overproduced because of higher demand than the merit products. Markets may also fail to control the manufacture and sale of goods like cigarettes and alcohol, which have less merit than consumers perceive. This imbalance brings about market failure.

  • Presences of Monopoly Business

There are two definitions of monopoly Business. When a single seller dominates the market, this is called pure monopoly, but a recent definition of monopoly business is when a company individually occupies 33% market share. Whatever may be under monopoly situation; customer lacks bargaining power. Here the seller himself sets Price. Lack of bargaining power is another cause of market failure. This market failure causes the imperfect markets which restrict output to maximize profit because one firm can control the market and can set higher prices.

  • Presence of externality

There are two types of costs and benefits.

  1. Private cost- Which is incurred by the individual person.
  2. External cost- which is incurred by the 3rd person although he is not the owner but be affected.

These two costs together are called a social cost.

  1. Private benefits- The benefits that the owner himself enjoys alone.
  2. External benefits- Where a 3rd person will be benefitted due to the owner of the 1st person.

These two benefits together are called a social benefit. For equilibrium, the social benefit must be equal to social cost. In reality, this never happens to cause market failure. The market failures, externalities are probably the easiest to understand and accept, particularly those related to environmental quality.

A positive externality occurs from the production or consumption of goods and service, which refers to the positive spillover. One of the examples of positive externality is less congestion from cycling. A negative externality occurs from the negative overflow which effects by third parties. One of the examples of negative is cancer from passive smoking, which negatively impacts on the health of people. The following graph presents the negative externality where the social cost is higher than private cost, and here industry will produce more until than is socially optimal.

  • Lack of information

It’s also the important reason for market failure because sometimes marketers may not supply enough information in the time of market transaction. Providing full information about product and market transaction to other parties may not be in the interests of one party.

One of the preconditions for equilibrium is that both the buyers and sellers will freely exchange information to each other. However, in real life, neither buyers nor sellers share information. This is called Asymetrix information (imperfect knowledge, it occurs where one party has different information to another party; it could lead to adverse selection) which leads to market failure.

  • Carrot and stick policy

Govt. should provide various incentives to the businessmen who are doing honest business and also gives punishment to the corrupt businessman. Reality is that across the globe government does provide a carrot to the dishonest people and provide stick (punishment) to the carrot business people. This inverse practice is responsible for market failure.

  • Lack of property right

In the market, when the property right of the owner is not ensured by the government then an entrepreneur will be demotivated for further production. By this way an economy will face underproduction that leads to market failure. When consumers and producers get their property right to own property then market work most effectively, but in some cases, property rights cannot efficiently be allocated to specific resources, and in those cases, market failure comes to light.

  • Unnecessary Government intervention

An active market always makes a distorted and inefficient market when the government intervened .

  1. Agriculture

Due to volatile prices and externalities of Agriculture, the market failures may occur.

  • Factor immobility

Factor immobility like geographical or occupational immobility is also responsible for occurring market failure.
Environmental concerns: effects on the environment as essential considerations as well as sustainable development.

Accomplishment (oOvercoming Market Failure)

To overcome those market failures some recommendations and solutions are given below

Mostly the home government can contribute to overcoming the causes for market failure.

  • Provision of Non-market Products and Indivisible Services

To maintain the supply and demand in the equilibrium point provision is a must. By applying various rules like Provision of Basic Infrastructure, Provision of Correct Information, Promotion of Competition and Improvement in Market Functioning, it is possible to overcome the market failure.

  • Control the size of private enterprises

Government can control the market failure by regulating and prohibiting monopolistic (monopoly houses), restrictive, and unfair trade practices.  Prevent mergers and amalgamation of competing units.  Allocation of resources among better alternative uses, and provision of institutional support.

  • Stabilization of aggregate demand.

Provide cheap credit facilities to specific sectors and stimulate their growth.

  • Standardization of business practices.

Doing emendation of inherent drawback in the market mechanism.
Providing necessary rules and procedures to regulate and control the speculative transactions. Hold down the equality of opportunity for all market stakeholders regardless of their gender, national origin, or religion. Put down the business from engaging in practices that would be harmful to the public. Protect and save small firms from unfair competitive abuses by big firms. Provide various incentives to the honest businessmen and must use the carrot and stick policy properly. Prevent unfair practices resulting from mergers or other forms of combinations such as price-fixing.

Government intervention to overcome market failure

  • Public goods

In a free market, public goods such as public parks, street lights, air and so on. Consumers need not pay for enjoying those. The government should make a law and policy to make the balance between private and public goods to overcome the market failure.
Merit goods / Positive externalities- In a free market, demerit goods are overproduced because of higher demand than the merit goods so to prevent this imbalance, government should provide the universal and moral education which has a definite social benefit.

  • Negative externalities

In the free market, negative externality occur from the negative spillover which effects by third parties that do not provide an efficient social outcome. The government can control the negative externality by taxing production, which causes pollution and harmful costs, and on the other hand, the government should offer the subsidy to encourage other forms to produce positive externality to gain social welfare.

  • Regulation of monopoly power

In a free market, Government policy and management of monopoly can lead to lower prices and greater economic efficiency.

  • Overcoming Asymmetric information

To overcome the asymmetric information and market failure, Government needs to invest in the business, gives signals, gives warranties, and should maintain no claims bonuses.


The market should behave natural, which is demand, supply, and price will operate in reasonable condition. However, when the government takes necessary improvement for the market, it becomes most inefficient, leading to market failure. Without the government intervention, market failure cannot be mitigated. There is no real model of a society to make the balance between demand and supply. So here needs to be some state protection of property rights and spending on national defense to bring the equilibrium situation of inefficient allocation of resources in a free market. Although it is very challenging for the government to intervene in macro-economic stabilization but without intervene, it is not possible to overcome the problems of market failure.


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Cite this paper

Market Failure Problems and How to Overcome Their. (2020, Sep 22). Retrieved from https://samploon.com/market-failure-problems-and-how-to-overcome-their/

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