Edexcel IGCSE Economics (4EC1) · Section A: The Market System
Specification points
- Market failure and its causes: externalities, and merit, demerit and public goods.
- Government intervention to correct market failure.
What is market failure?
Market failure occurs when the free market fails to allocate resources in society's best interest, producing too much of some goods and too little of others.
Causes
- Negative externalities (pollution) — the market over-produces because firms ignore the external cost.
- Positive externalities / merit goods (education, healthcare) — under-consumed because people undervalue their benefits.
- Demerit goods (cigarettes, alcohol) — over-consumed because people ignore the harm.
- Public goods (street lighting, defence) — non-rival and non-excludable, so the free-rider problem means the market fails to provide them.
Negative externalities → overproduction; merit goods → underconsumption; public goods → not provided.
Key definitions
| Term | Definition |
|---|---|
| Externality | A cost or benefit to a third party outside the transaction. |
| Merit good | A good under-consumed because its benefits are undervalued. |
| Public good | A non-rival, non-excludable good subject to the free-rider problem. |
Government intervention
Governments correct market failure using taxes (on demerit goods and pollution), subsidies (for merit goods), regulation and bans, provision of public and merit goods, and information campaigns.
Worked example
A factory pollutes a river. The social cost (illness, dead fish) exceeds the private cost to the firm, so it over-produces — a negative externality. The government could tax the firm to raise its private cost towards the social cost, cutting output towards the level best for society.
Common exam mistakes
- Confusing merit goods (under-consumed) with demerit goods (over-consumed).
- Calling healthcare a "public good" — it is usually a merit good.
- Forgetting to link the failure to over- or under-production.
Exam technique
Name the type of failure, explain the gap between private and social costs/benefits, and suggest a suitable government policy.
Quick revision
- Causes: externalities, merit/demerit goods, public goods.
- Public goods → free-rider problem.
- Intervention: taxes, subsidies, regulation, provision, information.