What is market failure?

Market failure occurs when the allocation of goods and services by a free market is not efficient, leading to a net negative impact on society. The key aspect of market failure is that the price mechanism, which typically guides the allocation of resources based on supply and demand, fails to account for certain external factors.

In the context of the correct choice, societal indirect costs and benefits are externalities that impact third parties not directly involved in the economic transaction. For instance, pollution created by a factory affects the health of nearby residents, but this cost is not reflected in the pricing of the factory's goods. Similarly, when a company provides benefits such as education or training, those positive externalities are often not captured by market prices. Therefore, the market does not reflect the true societal costs and benefits, leading to overproduction or underproduction of certain goods and services.

By recognizing that market outcomes may not align with the well-being of society as a whole due to these externalities, the choice accurately illustrates the concept of market failure as it demonstrates how the failure of the price mechanism to include these costs and benefits can lead to inefficiencies and a misallocation of resources.