Market failure

Market failure occurs when decentralized markets allocate resources inefficiently, leaving gains from trade unrealized or producing outcomes that do not maximize total surplus.

Externality: An externality is a cost or benefit of an activity borne by people who are not party to it. Unpriced spillover costs or benefits make private decisions diverge from social costs or benefits.
Pareto efficiency: An allocation is Pareto efficient when no change can make someone better off without making someone else worse off. It is a standard benchmark for judging whether a market allocation leaves feasible improvements.
Pigouvian tax: A Pigouvian tax charges an activity an amount equal to its marginal external cost. It can make decision-makers account for costs their activity imposes on others.
Government failure: Government failure occurs when public intervention produces outcomes worse than feasible alternatives because of political or administrative limitations. Corrective policies can introduce new distortions or costs instead of improving allocation.
Public good: A public good is non-excludable and non-rivalrous, so people can benefit without paying and one person's use does not reduce another's. Free riding weakens private incentives to provide goods whose benefits are shared.
Welfare economics: Welfare economics studies how resource allocations affect social well-being. Its tools connect market outcomes to efficiency and social welfare.
Cap-and-trade: Cap-and-trade limits total emissions and allows permits to be bought and sold. It addresses pollution externalities while letting firms trade toward lower-cost reductions.
Market efficiency: Market efficiency describes how effectively markets allocate resources or generate gains from trade. Competitive markets under ideal conditions can avoid the inefficiencies grouped under market failure.
Monopoly: A monopoly is a market with one seller and no close substitute for its product. Market power can restrict output and raise prices above competitive levels.
Consumer surplus: Consumer surplus is the difference between what buyers are willing to pay and what they actually pay. Lost consumer surplus can reveal the welfare cost of restricted or distorted trade.

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