Market failure refers to the situation where the free market fails to achieve an outcome that maximizes society’s welfare, of which imperfect information and the immobility of the factors of production, which refers to the inability of resources to move perfectly from one market to another in response to changing market conditions, would lead to market failure as well. In my essay, I explain how the above two factors cause market failure.
In this case of demerit goods, individuals are unaware of the social cost incurred during their consumption of the good. Both negative externalities of production as seen in the figures below. Without government intervention, MPB = MPC and output is at Qp. The social equilibrium Qs is at MSB = MSC. Since MSC > MSB, a deadweight loss is generated. Since Qp > Qs, the good is over-produced.
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