AQA A-Level Economics (7136) · Market Mechanism, Market Failure & Government Intervention
Specification points
- Types of market failure: externalities, public goods, merit and demerit goods, information failure.
- Positive and negative externalities in production and consumption.
- Market imperfections and inequality.
What is market failure?
Market failure occurs when the free market fails to allocate resources efficiently, so social welfare is not maximised. AQA covers externalities, public goods, merit/demerit goods, information failure and market imperfections.
Externalities
The key is the gap between private and social costs/benefits:
- Social cost = private cost + external cost; social benefit = private benefit + external benefit.
- Negative externalities (pollution) → over-production; positive externalities (education) → under-provision. Welfare loss occurs where MSC ≠ MSB.
Negative externalities → overproduction; positive externalities and merit goods → underconsumption.
Key definitions
| Term | Definition |
|---|---|
| Externality | A cost or benefit affecting a third party outside the transaction. |
| Public good | A non-rival, non-excludable good subject to the free-rider problem. |
| Merit good | A good under-consumed because its benefits are undervalued. |
| Information failure | When buyers or sellers lack full or symmetric information. |
Public goods
Public goods are non-rival and non-excludable, so consumers free ride and the market under-provides or fails to provide them (defence, street lighting).
Merit, demerit goods and information failure
- Merit goods are under-consumed and demerit goods over-consumed because people misjudge the true costs and benefits.
- Information failure (including asymmetric information) leads to misallocation, such as the market for "lemons".
Worked example
A factory pollutes a river: marginal social cost exceeds marginal private cost, so output exceeds the social optimum, creating a welfare loss. The market ignores the external cost — a negative production externality requiring intervention (topic 5.2).
Common exam mistakes
- Confusing merit goods (under-consumed) with public goods (non-excludable).
- Mislabelling the welfare-loss area.
- Treating any lack of information as asymmetric.
Exam technique
Draw the correct externality diagram, mark the market and social optima, shade the welfare loss, and identify the specific type of failure.
Quick revision
- Failures: externalities, public goods, merit/demerit goods, information failure.
- Social cost/benefit = private + external.
- Public goods → free-rider problem.