What Are the Signs of Market Failure?

Market failure occurs when a nation’s economy is unable to allocate resources efficiently among individuals. It is a wide ranging failure that usually results due to externalities. Signs of market failure include inequality, few raw materials that allow an economy to build and trade goods, and government intervention that chokes the trade and use of resources. This kind of failure may occur when one or more of these items are present. Several different factors outside of these can induce the problem, although these are among the most common.

Inequality occurs when one group or class of citizens consistently have more income or resources than another. This classic scenario comes from the feudal system of past history. The lords had land, castles, and resources that extended well past the resources of the serfs, who were made to work for the lords. This was a market failure because every individual in the economy was unable to succeed. The limitations placed upon serfs — who were often unable to keep the goods produced by their hands — made it difficult for them to rise above their lowly service.

Most countries have fixed borders, which limit their abilities to gather resources. Market failure occurs when a nation’s borders are so small that few resources exist to produce goods internally. Therefore, the nation must find willing trade partners who will provide the necessary resources or finished goods for economic advancement. Trade, however, is a two-way avenue. The nation must be willing to give up some of its goods — however limited they may be — in order to induce economic advancement and avoid market failure.

Government intervention is often a common issue or problem that creates market failure. Price controls and regulations are among the top two items that ultimately create market failure. A price control sets a minimum or maximum price individuals can charge others for goods. Minimum wage is a common price control; companies receive mandates on how much compensation they must pay to employees. If the minimum wage is higher than the market, however, goods will have higher prices, creating potential market failure when consumers cannot purchase these goods.

Government regulation occurs when a nation’s political class attempts to control how companies operate. Even when nations have copious economic resources, too much regulation can restrict the use of resources. This leads to lower production output and higher prices as the government attempts to control supply and demand. Regulations also add costs because a company must alter its operations to satisfy the government, who can make rules and requirements with no economic reasoning. Excessive government control in command economies completely destroys the market, resulting in the ultimate type of failure.