|Market Failure versus Government Failure|
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Market failure refers to market outcomes failing to result in socially optimal outcomes. Three sources of market failure are externalities, public goods, and imperfect information. An externality occurs when costs or benefits associated with the production or consumption of a good fall outside the market. The problem associated with a public good is that it is difficult to determine its value. When buyers and sellers have different amounts of information, adverse selection can occur. Any time a market failure exists there is a reason for possible government intervention to improve the outcome.
However, it is always possible that government intervention in the market meant to improve the market failure may actually make matters worse. This is referred to as government failure. Economic policy is often a choice between market failure and government failure. An optimal policy is always one that equates marginal benefits and marginal costs.
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