8 Journal of Regulatory Compliance Vol. I
best they can and choosing the path that promises the greatest net return. 1
Consumers seek the greatest value for the lowest possible price, producers
seek the greatest profits, and jointly, through repetitive voluntary
transactions, market prices emerge at levels that assure the greatest surplus
for society. 2 Markets fail when something interferes with these market
mechanisms and prices are unable to adjust to achieve efficient outcomes. 3
When the failure is the result of inherent flaws in the market, it is called a
market failure. 4 Key to any discussion of markets and their flaws is to
understand the difference between “market failures,” in which the market,
left entirely alone, would yield sub-optimal outcomes, 5 and a failure caused
by external forces, such as government regulation.
Among the most commonly-referenced market failures are externalities
and public goods, increasing returns (and declining marginal costs), and
information asymmetries. 6 Each particular market failure arises from some
specific problem with the voluntary transactions that lead to market prices.
When an externality is present, one individual does not receive all of the cost
(or all of the benefit) of the transaction and, as a result, will engage in too
many (or too few) of the relevant transactions. 7 Monopolies arise from
increasing returns and declining marginal costs. Monopolies eliminate the
market competition that is necessary for prices to be independent of the
control of any single entity or coordinated group of entities. Information
asymmetry refers to a significant imbalance in the information possessed by
parties to the voluntary transaction;8 the party without information may enter
into a transaction that is not actually beneficial.
1. Michael C. Jensen & William H. Meckling, The Nature of Man, 7 J. APPLIED CORP.
FIN. 4, 5–7 (1994).
2. See, e.g., Roland N. McKean, The Unseen Hand in Government, 55 AM. ECON. REV.
3. Charles Wolf, Jr., A Theory of Nonmarket Failure: Framework for Implementation
Analysis, 22 J.L. & ECON. 107 (1979).
4. HENRY N. BUTLER, CHRISTOPHER R. DRAHOZAL & JOANNA SHEPHERD, ECONOMIC
ANALYSIS FOR LAWYERS 125–26 (3d ed., 2014).
5. Some scholars insist that markets are capable, over time, of correcting even those flaws
inherent in the market at a given time. CLIFFORD WINSTON, GOVERNMENT FAILURE VERSUS
MARKET FAILURE: MICROECONOMIC POLICY RESEARCH AND GOVERNMENT PERFORMANCE 76
6. Wolf, supra note 3, at 108–10.
7. Positive externalities and public goods share a fundamental characteristic, that of a
positive spillover to others. With an externality, the spillover is partial; with a public good,
every individual enjoys all the benefit of the good.
8. All transactions are characterized by some level of information asymmetry. For
example, the grocer does not know precisely how much the shopper prefers sweet snacks over
salty snacks, leaving the shopper with an information advantage. The imbalance does not
interfere with market mechanisms unless the information disparity is significant and pertains
to a material element of the transaction.