Market failures are generally viewed as negative things that should be avoided, but sometimes they are unavoidable. They are also known as market imperfections or market distortions.
A classic example of an unavoidable market failure is the tragedy of the commons; in this case, it is impossible for everyone to agree on how to efficiently use shared resources. When people have different preferences over what to do with those resources, it can lead to inefficient outcomes.
A market failure occurs when an action taken in the name of profit causes harm to others and cannot be corrected through traditional economic incentives. There are two types of market failures:
Perfect information failure – when buyers and sellers have perfect information, but some goods are too expensive to buy or sell (e.g., land, patents).
Asymmetric information failure – when one party has more information than another party (e.g., buyer doesn’t know if he’ll like the product until after he buys it).
Market failures don’t always mean that free markets can’t work well; sometimes they’re just not perfect. For example, in some cases government intervention may be necessary for a market to function optimally.
