Edit: Is it possible to broadly categorize the ways in which market failures occur into relatively few categories? If so, what are they?
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Any situation where markets fail to clear leads to market failure. Some common reasons for this are:
Externalities, or agents not being responsible for costs or benefits of their actions
Information assymetry, or agents operating with different information
- Irrationality, or agents doing random things for no reason
- Principal agent problems, where someone entrusted with others funds uses them wastefully
- Productive inefficiency, or firms failing to produce goods effectively given the allocated capital (think using Gatorade to water plants)
- Allocative inefficiency, where firms are not provided the appropriate capital
- Economies of scale, or the problem of capitalist firms failing to grow large enough to establish a service
- Destructive competition- eg, private militaries blowing each other up
- Shortsighted management of natural resources
- Monopoly
- Moral hazard, adverse selection, and other problems in contract theory
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$\begingroup$ There are only 2 causes of market failure: externalities and the inability for a free market to move between Pareto Optima. NONE of the following are market failures: Information asymmetry, irrationality, principle-agent problems, productive or allocative inefficiency, economies of scale, short sightedness, or moral hazard. I wrote an article on what market failure is, and you just recited all the usual myths. governology.wordpress.com/2016/07/05/… $\endgroup$ – B T Jul 5 '16 at 8:37
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$\begingroup$ Not at all. Externalities are when costs or benefits are imposed on someone else without their consent. The inability for a free market to move between Pareto Optima is a function rather of inaction - this is embodied in the second welfare theorem of economics. If your economy consists of 2 people, one with everything and one with nothing, utility could almost certainly be improved by a bit of wealth sharing. But the free market can't do that on its own. The likely outcome is that the person without resources would be employed by the other in some way. $\endgroup$ – B T Jul 5 '16 at 9:03
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$\begingroup$ Sure.. but the point is that the market's inability to move to a state where one person is worse off means that it can't move to a more totally optimal state by making one person a little worse off but making a lot of people much better off. This isn't an externality, but is a market failure. $\endgroup$ – B T Jul 5 '16 at 23:35
:)
$\endgroup$ – Herr K. Feb 26 '16 at 21:26