Markets are a good way to organize economic activity, but occasionally they fail to allocate goods and services efficiently. When this happens, the government can help. Market failure occurs when prices don’t reflect social costs and benefits of products and services. Or, when markets produce pollution resulting in damage to ecosystems and human health as in the case of a negative externality. Monopolies can also lead to inefficiency because they have the power to control how much they produce, and therefore, the price of products. To ensure prices are high, they hold back production, which hurts society. Finally, we talked about information asymmetry where one party has more information than the other, which can result in a situation where marginal benefits don’t equal marginal costs.
Why is all this important? Because we have scarce resources and we want to make the best decisions possible. Best, meaning the most efficient whereby we minimize waste. When markets fail to allocate goods and services efficiently people pay too much for products, some markets under-produce goods and services that could help more people, and we threaten human health and the environment. These things matter in our daily lives so it’s important to prevent them from occurring by providing incentives to ensure efficiency.