Here is a basic overview of where the market fails:
The free market was designed for the management of goods and services which are both rival and excludable. Anything which is not rival and excludable is inherently not efficiently managed by the market as it is set up today. In other words, the market effectively manages pieces of the whole, as long as they can be confined, defined and possessed easily, but the more these pieces are parts of greater systems, the more the market fails, causing the systems to fail, failing our preferences, our ecosystems, and our economies.
If I eat a peanut butter and jelly sandwich, you can not also eat the same peanut butter and jelly sandwich. The PB and J is rival. However, the list of ingredients, and preparation instructions may be be valuable to both you, and I. The peanut butter and jelly sandwich is rival. The ingredients information is non-rival. In fact, if you are preparing food for my potluck. Sharing a cookbook of mine, with you, may turn out to be beneficial to myself.
A situation that might concern us to a greater extent. As I explained earlier, a rival good is a good which depreciates value with use.
THe Catskill watershed provides New York City with water purification. This was a good enjoyed by the public and water companies. Eventually sewage and pesticides from surrounding areas threatened the water supply and the EPA had to step in. After changes, the natural abiotic processes such as soil absorption and filtration, and biotic recycling improved the water to levels back above standards.
In hindsight the waste dumping and pollution was extremely expensive to the collective group that used the water. The watershed then performed non-rival eco-system services for all affected by the water. The eco-system is wildly complex, and in any given place we may be affecting any number of eco-system services, which are extremely difficult to calculate value for.
In the case of consuming resources, as stock-flows it is easier to measure, calculate and create ownership, with fewer externalities. With eco-system services, we it is highly difficult to measure, calculate and create ownership, and externalities exist across the board.
For instance, if i use a tree to make a table, that tree is no longer as valuable as a stump. The tree is rival. However, if walking down the local side walk next to the river, I am using the tree’s flood prevention, this is not rival and I would be happy if others also used this service that the tree provides. The tree as material is rival. The tree as providing a service is non-rival.
As a system of measurement, the market fails in maximizing the benefit of non-rival goods. In the case of the tree that provides, water cleansing, river bed stability, oxygen, and carbon sink to all; our economy does not have an accurate way of valuing our ‘preferences’ toward maintaining the existence of that tree.
It would be appropriate to note that many market-failures revolve around natural-resources, so specifically in these areas, the market, is not capturing our true preferences.
Excludable goods, are those goods which can be made private. An example is a cook book. “This cook book is mine, because the law says so.” Example of non-excludable goods are fish in the oceans. When fish are out of the water, they are eaten, by one or a couple of persons becoming excludable and rival. Because the ocean is an open access regime, the fish are non-excludable. It may be intuitive that for a good to be efficiently allocated in our market it must be excludable, or able to be privatized.
Therefore, to judge whether a good is able to be efficiently allocated by the market it must be rival, excludable, generate no externalities and the well-being of future generations must not be affected by its current use. Unfortunately, no good or service provided by nature meets all of these criteria. So in the case, of our market. The idea that we are constructing a world of our choosing is illusory. Based on a monetary voting system we are producing the rival and excludable goods of our preferences. Unfortunately, this occurs at the costs of devalued, non-rival, and non-excludable goods, for which we cannot voice our preferences!
This may come to a relief, to people who were believing that it was simlpy our collective preferences that have led us toward the levels of natural world destruction we are currently seeing.
We see these intersections with goods in open access regimes, excludable and non-rival goods pure public goods and market goods.
Other Market failures:
Substitutability of capitals