AQA Specification focus:
‘The difference between complete market failure (resulting in a missing market) and partial market failure (where a market exists but contributes to resource misallocation).’
Introduction
Markets often fail to allocate resources efficiently, leading to welfare losses. Economists distinguish between complete market failure and partial market failure, each with unique implications.
Understanding Market Failure
Market failure occurs when the price mechanism does not lead to an efficient allocation of resources, resulting in misallocation and welfare loss.
Market Failure: A situation in which free markets fail to allocate resources efficiently, leading to under-production, over-production, or missing markets.
While all forms of market failure undermine efficiency, it is useful to separate them into two broad categories: complete and partial.
Complete Market Failure
Characteristics
Complete market failure occurs when a market does not exist at all, despite there being a need or demand for a good or service. Economists often call this a missing market.
No private firm supplies the good because it is not profitable.
Consumers cannot purchase the good even if they wish to.
The good’s characteristics make it impossible to provide under normal market conditions.
Causes
Public goods: Their non-rivalry and non-excludability discourage private provision.
Externalities: Strong external benefits may prevent markets from emerging if private incentives are insufficient.
Missing Market: A situation where a good or service is not provided by the market at all, despite being desired by society.
Examples
National defence: No private firm can profitably supply it because non-payers cannot be excluded.
Street lighting: Once provided, all benefit regardless of payment.
Clean air: No private market can exist for something non-excludable.
Partial Market Failure
Characteristics
Partial market failure arises when a market exists but leads to inefficient outcomes because of resource misallocation.
Goods and services are produced and consumed, but in the wrong quantities or at the wrong prices.
Efficiency is undermined due to imperfect market mechanisms.
Causes
Negative externalities: Over-production or over-consumption (e.g. pollution, smoking).
Positive externalities: Under-production or under-consumption (e.g. vaccinations, education).
Imperfect information: Consumers and producers making poor choices.
Market power: Monopolies restricting output to raise prices.
Resource Misallocation: The inefficient use of scarce resources, resulting in goods or services being under- or over-produced relative to the socially optimal level.
Examples
Cigarettes: Market exists, but negative externalities mean over-consumption compared to the socially optimal quantity.
Healthcare: Private markets may under-provide due to positive externalities and imperfect information.
Monopolies: Market exists, but firms restrict supply and charge higher prices than in a competitive equilibrium.
Key Differences Between Complete and Partial Failure
Market Existence
Complete failure: No market exists (missing market).
Partial failure: Market exists but misallocates resources.
Resource Allocation
Complete failure: Zero allocation occurs — no provision of the good.
Partial failure: Misallocation occurs — provision is too much or too little.
Example Goods
Complete: National defence, public broadcasting in early years, street lighting.
Partial: Education, healthcare, cigarettes, monopolised industries.
Implications for Economic Policy
Governments respond differently depending on whether market failure is complete or partial.
In the Case of Complete Market Failure
State provision: Government directly provides the good, funded by taxation (e.g. armed forces, police).
Public sector contracts: Outsourced but taxpayer-funded provision.
In the Case of Partial Market Failure
Indirect taxation: Reduces demand for goods with negative externalities.
Subsidies: Encourage consumption of goods with positive externalities.
Regulation: Restricts harmful activities or compels provision of essential services.
Competition policy: Prevents abuse of monopoly power.
Diagrammatic Representation
While not always required, diagrams can illustrate the difference:
Complete failure: No supply curve exists; demand remains unmet.
Partial failure: Supply and demand curves exist, but the equilibrium diverges from the socially optimal level due to externalities or distortions.
Summary of Key Points
Complete market failure = missing market. No provision occurs at all.
Partial market failure = misallocation of resources. Market exists, but output is inefficient.
Causes differ, but both represent significant failures of the price mechanism to achieve efficiency.
Government intervention strategies depend on whether the market is absent entirely or simply malfunctioning.
FAQ
Complete market failure is most often associated with public goods, which are non-excludable and non-rivalrous. Examples include defence, flood barriers, and lighthouses.
Because providers cannot exclude non-payers, there is no incentive for private firms to supply them. This creates a missing market where the good or service is not provided at all, despite clear demand.
Partial market failure is typically illustrated using cost and benefit curves.
Negative externalities: MSC above MPC, leading to over-production.
Positive externalities: MSB above MPB, leading to under-production.
These diagrams highlight the gap between market equilibrium and the socially optimal output, visually showing misallocation.
Yes, context matters.
In some countries, healthcare may face complete failure if no market exists for universal provision.
In others, private healthcare markets exist but suffer partial failure due to under-consumption, imperfect information, or inequality.
This shows that the classification depends on the institutional setting and extent of provision.
Complete market failure is relatively rare because most goods and services can be provided, even if inefficiently.
Partial failure is far more common since even functioning markets often misallocate resources due to externalities, imperfect competition, or poor information.
In practice, governments often face more issues correcting partial failure than complete absence.
Government responses vary:
Complete market failure: State provision or funding is usually essential (e.g. national defence).
Partial market failure: Governments use targeted measures such as:
Subsidies for merit goods.
Taxes for demerit goods.
Regulation to correct information gaps.
The extent and type of intervention depend on whether the market exists but misallocates or fails to exist altogether.
Practice Questions
Explain the difference between complete market failure and partial market failure. (2 marks)
1 mark for identifying that complete market failure occurs when there is a missing market (no provision of the good or service at all).
1 mark for identifying that partial market failure occurs when a market exists but resources are misallocated (over- or under-production).
Using examples, explain why complete market failure and partial market failure both lead to inefficiency in the allocation of resources. (6 marks)
Up to 2 marks for definition or clear explanation of complete market failure (e.g. missing markets such as national defence or street lighting).
Up to 2 marks for definition or clear explanation of partial market failure (e.g. markets existing but leading to over-consumption of demerit goods like cigarettes or under-provision of merit goods like healthcare).
Up to 2 marks for explaining inefficiency in resource allocation in each case:
Complete failure = zero provision, so needs/demands are unmet.
Partial failure = misallocation, so output diverges from the socially optimal level.
(Allow examples for either case to gain marks; maximum 6 marks in total.)
