Market Failure:

In the world around us, we see cities engulfed in smog, rivers being polluted, vegetated land suffering from soil degradation, erosion and excessive grazing and water tables going down. We have also witnessed high rates of deforestation, coastal ecosystems being threatened, depletion of ozone layer, loss of biodiversity, etc. Our economic theory, however. teaches us that market mechanism is efficient at allocating resources. Are the levels ofenvironmental deterioration that we presently witness, optimal? In this unit, we will study, why under certain situations, markets may not function efficiently and thus are not providing optimal levels of certain goods and services. To examine this, we first need to understand efficiency properties of markets.

We begin by defining two key concepts: competitive equilibrium and Pareto optimality. We discuss two central results regarding the efficiency properties of competitive equilibria, a known as the fundamental theorems of welfare economics. We then study a number of ways in which actual markets may depart fiom this perfectly competitive ideal, and where q a result, market equilibrium fail to be Pareto optimal, a situation known as market failure.