3.4 — Welfare Economics & Market Failures — Class Content



Today we continue to consider how markets work and why (and when) they are so efficient at allocating resources and solving social problems. We take a crack at defining efficiency in a few ways: allocative, productive, Pareto, and Kaldor-Hicks efficiency. We then discuss Welfare Economics and I summarize three conditions about when markets are good & efficient: 1. Markets are competitive 2. Markets reach equilibrium 3. Markets do not have externalities

This leads us into a discussion of market failure, when markets aren’t efficient because something prevents the price system from working properly. We talk about several types of market failures: collective action problems, public goods, and externalities.


Your textbook does cover efficiency and welfare economics in Chapter 14, in the context of general equilibrium theory, which is a bit too advanced for us to spend sufficient time to cover. Thus, I would not recommend reading that chapter unless you are prepared to dive into new tools (Edgeworth diagrams, production possibilities frontiers) that I will not cover in this course.

Chapter 16, however, is a pretty accessible discussion of externalities and public goods.

The following Wikipedia entries can also provide more background on today’s concepts (which are well known and standard among economists):

On Efficiency & Welfare:

On Market Failures (and their Solutions):