Explain the concept of market failure and provide an example.

Explain the concept of market failure and provide an example.

Market failure refers to a situation where the allocation of goods and services by a free market is inefficient, leading to a suboptimal outcome for society. It occurs when the market fails to allocate resources in a way that maximizes social welfare.

One example of market failure is the existence of externalities. Externalities are the costs or benefits that are not reflected in the market price of a good or service. For instance, pollution from a factory may impose costs on the surrounding community in terms of health issues and environmental degradation. These costs are not accounted for in the market price of the goods produced by the factory, leading to an overproduction of the goods and an inefficient allocation of resources.