What does the term "market failure" mean?

• A. A situation of excess supply in the market
• B. A scenario where markets operate perfectly
• C. An inefficiency in the allocation of goods by the market
• D. A failure of businesses to turn a profit

Answer: (C)

The term "market failure" refers to an inefficiency in the allocation of goods by the market, which can occur for various reasons. In a market economy, resources are typically allocated based on supply and demand; however, when this process does not lead to optimal or fair outcomes, it is classified as a market failure. This can happen due to several factors such as externalities, public goods, information asymmetries, or monopolies, where the full costs or benefits of a product are not reflected in its market price.

For example, pollution from a manufacturing plant imposes costs on society that are not captured in the price of goods produced by that plant, which leads to overproduction of those goods. Consequently, the market does not allocate resources efficiently, resulting in a failure to achieve an optimal social outcome. Therefore, identifying and addressing market failures is crucial for policymakers to enhance overall economic efficiency and welfare.