We saw in the previous module that when markets are competitive, we get allocative and productive efficiency. Efficient allocation and efficient production with the maximum economic surplus. And we talked about the deadweight loss that can happen from underproduction and overproduction.
So what happens when markets don't work as well as they should and supply and demand don't lead to the efficient outcome? This is called market failure. Sometimes you'll hear people use the term market failure to mean the market didn't give me the thing I want at the low price I expect and deserve.
That's not market failure. We economists mean something very specific with that term. Let's talk about a few reasons for market failure when a market doesn't reach the efficient outcome.
First, externalities. which is the topic we'll discuss in this module. This is when the choices made by buyers and sellers don't reflect the full set of costs and benefits.
For example, driving our cars creates a lot of benefits for us and we're aware of certain costs that we take on like gas and wear and tear. But we don't face the full cost of the pollution and traffic congestion that our own personal driving causes. We might end up driving too much, which you can think of as overproduction of driving.
because we're not considering the true marginal cost. Second, government failure, which we'll talk about in this module and the next. This is when government regulations create inefficiencies in the market that lead to underproduction or overproduction and therefore deadweight loss.
Third, Market power, which we'll get to in a later module. I've referred to that price taker and competitive markets assumption a lot as being necessary for an efficient outcome. But what happens when a company does have pricing power?
What if they're the only game in town, a monopoly that controls all the supply of a valuable medicine? What happens to efficiency then? Fourth, asymmetric information, which we'll also talk about later.
For markets to be efficient, it's important for everyone to understand their costs and benefits. But what if there's private or hidden Information. Like the person you're buying a used car from has a much better idea of whether it's actually in good shape or not. How does that affect whether prices reflect the true benefits and cost?
And finally, Irrationality. This can lead to bad decisions, and that would be people systematically making errors that lead them to not really follow their marginal cost and marginal benefit. The field of behavioral economics focuses on a lot of these issues, and we'll discuss them towards the end of the course. Markets are very good at being efficient, getting the products people want to those who are willing to pay for them from the companies that can do so at the lowest prices. But they're not flawless.
and they can break down in some predictable ways. Sometimes the solution to that is government action. But remember that government is people making choices and following their self-interest.
So it's not surprising that the government can fail as well and sometimes make things worse.