Which factor can lead to market failure?

Market failure occurs when the allocation of goods and services is not efficient, and one primary cause of this inefficiency is externalities. Externalities are costs or benefits that affect third parties who did not choose to incur that cost or benefit. A strong example of a negative externality is pollution; when a factory emits pollutants, it can harm the environment and public health without bearing the cost of that harm. This means the market may produce more of the harmful good (like factory outputs) than is socially optimal, leading to overproduction and societal costs that are not reflected in the market price.

In contrast, perfect competition represents an ideal market structure where resources are allocated efficiently and prices reflect true costs, public goods, if provided efficiently, are available for all without detracting from others, and strict regulatory frameworks are often put in place to correct market failures themselves. Therefore, while those factors can influence market dynamics, it is the presence of externalities that directly leads to market failures by disrupting the balance between private costs and social costs.