Market Failure:

In political and economic theory, it is a common place to say that government is necessary because of the existence of public goods. As discussed in unit I also these are the goods, which everyone wants.  But nobody wants to bear the cost of supplying. This is known as free-riders' problem.

Public goods are some times supplied by the private sector and private goods -by the public sector. The debate goes on that the market economy serves to secure an efficient use of resources in providing for private goods.

With the presence of free riders makes it difficult or impossible for market to provide public goods efficiently. In this case private arrangements are usually ineffective and the public good must be subsidized or provided by governments, if it is to be produced efficiently.

Example: Demand for clean air cannot be calculated, as the benefits of a cleaner environment cannot be stopped for others to use. Public goods characteristics of clean air include weather, driving patterns, and industrial emissions to determine air quality, in a region. Any effort to clean up the air will generally improve air quality throughout the region.

Consequently, clean air is non-exclusive. It is difficult to stop any person from enjoying it. Because clean air is a public goods, it is difficult to estimate people's demands for it. There is no explicit market for clean air and thus no directly observable market prices can be interpreted as the rate at which people are willing to trade clean air for other commodities. However, we can estimate people's  willingness to pay for clean air from the housing market on the grounds that households will pay more for a home located in a area with good air quality than for an otherwise identical home in an area with poor air quality. More generally, people's demand for clean  air like the demand for most public goods, vary depending on the amounts of clean air available and on their individual tastes.

Market failure is thus commonly observed feature, not only when economy is riddled with monopolies but even under competitive conditions viz. uncertainty of future incomplete information (both technical and economic) and deliberate attempts by sellers to influence demand forces through selling techniques. In this context two economic arguments can be provided:

1) To allocate and comprise policies and actions of the government designed to counteract the inefficient outcomes of market  functioning.

2) Counteraction of eco-power through which the state tries to bring income and wealth.

Similarly, an unregulated market economy tends to exhibit instability (cyclical or otherwise) in terms of important macro economic  variables like income, employment, prices and output and it is considered a legitimate function of the state to protect the economy against the destabilizing forces.