Market Failures
What does it mean for a market to “fail”? Adam Smith described how pursuit of self-interest leads firms to cater to the needs of consumers and produce the “right” amount of each good. What is the “right” amount? The amount that benefits society. A market fails when it doesn’t “get it right” when the interaction of producers and consumers produces the “wrong” amount. Smith recognized that there are certain public goods – goods that are desired and valuable but are not profitable to produce because, once produced, they belong to everyone so no one will pay for them. Some goods produce negative “externalities” – another market failure – which means they produce some harm to society but those involved don’t bear the costs. Smith recognized these market failures and emphasized that his invisible hand theory is valid only for competitive, well-functioning markets.
For a discussion of the limits of markets, see an interview with Robert Kuttner, author of Everything for Sale: The Virtues and Limits of Markets
