Market Failure: Definition & Causes

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: What Is a Business Organization? - Structure, Types & Examples

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
Your next lesson will play in 10 seconds
  • 0:03 Market Failure: Definition
  • 0:29 Externalities
  • 1:24 Monopolies
  • 1:54 Public Goods
  • 2:46 Merit & Demerit Goods
  • 3:46 Lesson Summary
Save Save Save

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Log in or Sign up

Speed Speed

Recommended Lessons and Courses for You

Lesson Transcript
Instructor: Kat Kadian-Baumeyer

Kat has a Master of Science in Organizational Leadership and Management and teaches Business courses.

When the market for a given good or service fails to efficiently allocate the resources and utility of that market, it's called market failure. In this lesson, we'll explore some of the main reasons for market failure.

Market Failure: Definition

In economics, equilibrium is when the demand curve and the supply curve intersect, and consumers and suppliers enjoy maximum combined utility and profit. Market failure is a lack of equilibrium, during which consumers experience suboptimal utility and/or suppliers experience suboptimal profits. There are different types of market failure. Let's explore some of the causes for market failures.


One cause of market failure is externality, which can be positive or negative. Externalities occur when the market demand for a product or service shifts and an unwitting third party is affected by the change.

Positive externalities occur when a third party inadvertently receives some benefit from a consumer's or supplier's economical choice. For example, as people become more conscious of their carbon footprint, the demand for big, gas-guzzling cars decreases. So, car manufacturers make fewer sales. However, the demand for clean public transportation may increase, a positive impact for public transportation.

With negative externalities, a third party is negatively impacted by a shift in supply or demand. For instance, building a new freeway ramp may alleviate highway congestion; however, if it is built on land that was once used for a botanical garden, those who once enjoyed visiting the garden will experience a negative impact.


Monopolies develop when a single supplier controls the market. Monopolies can cause market failure by under-supplying the market with their products or services. For example, consider the issue of trash management in a large city.

Now suppose that one trash management company creates a monopoly of sorts. If the garbage management company is unable or unwilling to perform its duties, the city will be overrun with trash. As a result, city residents become the innocent victims of the sudden shift in supply.

Public Goods

Public goods are goods whose total cost of production does not increase with consumption. They cause market failure because a market doesn't truly exist for these products.

This cause of market failure results from three smaller causes. Non-excludability means that the public benefits from the goods without paying for them. Non-rival consumption means that each person enjoys the goods without taking away from another person's enjoyment of the same goods. Non-rejectability says that people cannot reject the good.

Consider a public street lamp, for example. While the street light serves a purpose, the number of people utilizing it does not affect the demand for its luminous glow. To take this concept one step further, it's in no business's interest to illuminate every dark street corner if there's no real benefit. The free riders benefit because they enjoy illuminated streets without paying for the service.

To unlock this lesson you must be a Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use

Become a member and start learning now.
Become a Member  Back
What teachers are saying about
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 200 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create an account