Market failure exists when the competitive outcome of markets is not
efficient from the point of view of the economy as a whole. This is
usually because the benefits that the market confers on individuals or
firms carrying out a particular activity diverge from the benefits to
society as a whole.
When free markets do not maximise society's welfare, they are said to
'fail' and policy intervention may be needed to correct them. Many economists have described climate change as an example of a market failure – though in fact a number of distinct market failures have been identified.
The core one is the so-called 'greenhouse-gas externality'. Greenhouse gas emissions
are a side-effect of economically valuable activities. Most of the
impacts of emissions do not fall on those conducting the activities –
instead they fall on future generations or people living in developing
countries, for example – so those responsible for the emissions do not
pay the cost. The adverse effects of greenhouse gases are therefore
'external' to the market, which means there is usually only an ethical –
rather than an economic – incentive for businesses and consumers to
reduce their emissions. As a result, the market fails by over-producing
greenhouse gases.
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Negative externalities and government intervention
