Question

Describe the 4 causes of market failure. Why is it safe to assume that the national defense will always be provided by the government and not the market?

Answer 1

The main causes of market failure are as follows:

1. Externality: Externality refers to the impact the third party faces by the production/exchange of goods between two other parties. This can be negative or positive depending upon the impact the process has on the third party.  It is usually measured in terms of social and private benefits accruing to a person.

2. Public Goods: The goods whose increased consumption doesn't lead to fall in the value of the good. It is both non-rival and non-excludable. However, if a section of society paying for it stops paying, it leads to free rider problem.

3. Market Control: When either the buyer or the seller tries to determine the price of the commodity, it leads to failure as the market demand and supply play no role in determining the price.

4. Imperfect information: This means that either of the party has incomplete information about either the product quality or the price prevailing, this leads to inefficient working of the society.

  Since a market fails to provide public good optimally, the market doesn't provide one. National defense is also a public good and it is better to be provided by the government rather than the market.