Imperfect market outcomes are corrected through a reallocation of resources or change in incentive structure. Economists have different opinions about the nature of market failures and what (if any) measures need to be taken to prevent or correct them.

What is a Market Failure?

It's impossible to identify a solution for market failure without clearly identifying what market failure is and why it persists. The common interpretation of market failure – failure to live up to the standards of perfect competition in general equilibrium economics – can be identified in many, if not all, markets.

Price equilibrium is a moving target, however. Think of all the firms and consumers in a market as runners in a race, except that the finish line keeps moving left, right, up and down.

A more realistic interpretation of market failure is a scenario in which economic participants are not properly incentivized to push markets toward a more efficient outcome. This is where most academic economic literature is concentrated.

Possible Corrections

Using the broad, perfect-competition definition, market failures are corrected by allowing competing entrepreneurs and consumers to push the market further toward equilibrium over time. Markets tend toward equilibrium constantly, never quite reaching it. This is because of limitations in human knowledge and changing real-world circumstances.

Some economists and policy analysts propose a litany of possible interventions and regulations to compensate for perceived market failures. Tariffs, subsidies, redistributive or punitive taxation, disclosure mandates, trade restrictions, price floors and ceilings, and many other market distortions have been justified on the basis of correcting inefficient outcomes.

Other economists argue that markets are recognizably imperfect, but market failure is improperly framed. Rather than asking if markets fail relative to some ideal (perfect competition), they contend that the question should be whether markets perform better than any other process that humans might invoke.

Free market economists, including Milton Friedman and F.A. Hayek, argue that markets are the only known discovery process proven to be capable of adjusting correctly to inefficiencies. They contend that regulation interferes with this discovery process, making inefficiencies worse rather than better.

  1. How do externalities affect equilibrium and create market failure?

    Discover the ways that externalities lead to market failure. Externalities are costs or benefits that go to a third party, ... Read Answer >>
  2. How does a monopoly contribute to market failure?

    Read a simple overview of the theory of market monopoly, where it originated and some contemporary challenges to the classical ... Read Answer >>
  3. Why are there no profits in a perfectly competitive market?

    See why economic profits are theoretically impossible in a perfectly competitive market and why some economists use perfect ... Read Answer >>
  4. How does adverse selection contribute to market failure?

    Examine an brief introduction to the adverse selection theory of market failure, and find out why economists disagree about ... Read Answer >>
Related Articles
  1. Personal Finance

    The Ultimate List of Painful Financial Mistakes

    Here are 24 preventable tax and investment mistakes that advisors see often; mistakes that can ruin your retirement planning.
  2. Small Business

    In Entrepreneurship, Failure Doesn't Have to Be Fatal

    There is an inherent risk to starting any type of business, but being an entrepreneur with a plan can help you succeed or try again if necessary.
  3. Trading

    Bucking The Trend With Pattern Failure Strategies

    The best trade could be in the opposite direction when a classic price pattern doesn't behave according to ideal rules.
  4. Investing

    This Stock Correction Is Now the Longest in a Decade

    By this methodology, the 2018 stock market correction is still underway.
  5. Managing Wealth

    Top Reasons Why M&A Deals Fail

    A significant number of M&A transactions result in failure. Here are the top reasons why it happens.
  6. Taxes

    4 Things to Know Before Filing Taxes This Year

    Keeping these four things in mind will help this tax season go more smoothly for you.
  7. Investing

    Distinguish A Stock Price Correction With A Price Trend

    We explain how you can use trend lines to help avoid market corrections.
  8. Investing

    Why a Stock Market Correction May Lead to Overreaction

    Today's investors, complacent from low volatility and soaring indexes, may overreact to a correction.
  9. Insights

    Why Can't Economists Agree?

    Learn the many reasons why economists can be given the same data and come up with entirely different conclusions.
  10. Investing

    Nasdaq Could Fall 15% or More: Morgan Stanley

    Morgan Stanley's Michael Wilson warned that it's tech's turn to feel some pain.
  1. Market Failure

    Market failure is the situation in which there is an inefficient ...
  2. Possibility Of Failure (POF) Rates

    A possibility of failure rate is likelihood that a retiree will ...
  3. Competitive Equilibrium

    A competitive equilibrium is when profit-maximizing producers ...
  4. Technical Correction

    A technical correction is a decrease in the market price of an ...
  5. Too Big To Fail

    "Too big to fail" is a term for a business that has become so ...
  6. Subsidy

    A subsidy is a benefit given by the government to groups or individuals, ...
Trading Center