Which of the following situations is an example of market failure in economics?

Introduction / Context:
Market failure is a central idea in microeconomics and public policy. It describes situations where free markets, left to themselves, do not allocate resources efficiently from the perspective of society as a whole. Recognising examples of market failure helps to understand why governments sometimes intervene through taxes, subsidies, regulation or public provision. This concept is also useful for marketing professionals who need to understand regulatory environments and social responsibility.

Given Data / Assumptions:

• In a perfectly competitive market with no distortions, prices reflect both private costs and benefits.
• Social cost includes both private costs borne by producers and external costs imposed on others.
• Market failure occurs when the market outcome is inefficient or undesirable from a social welfare perspective.
• The question asks which option describes such a failure.

Concept / Approach:
One classic source of market failure is externalities. When production or consumption imposes costs (negative externalities) or benefits (positive externalities) on third parties that are not reflected in market prices, the market outcome will differ from the socially optimal one. If prices do not include the full social cost of production, firms may produce and sell more than is optimal, leading to overuse of resources or environmental damage. Other sources of market failure include public goods, asymmetric information and market power, but the option mentioning social cost clearly matches the theory of externalities.

Step-by-Step Solution:
Step 1: Recall that social cost = private cost of producers + external cost imposed on others. Step 2: Recognise that when prices equal only private cost and ignore external cost, producers face too low a cost from society point of view. Step 3: Understand that this leads to overproduction relative to the socially efficient level, which is a classic case of market failure. Step 4: Examine the options and identify which one refers to prices not reflecting full social cost. Step 5: Conclude that option A correctly describes market failure due to negative externalities.

Verification / Alternative check:
Consider a factory that emits pollution into a river while producing a chemical product. The factory pays for labour, raw materials and equipment, but it does not compensate downstream communities for health costs or clean-up. The market price of the chemical reflects only the private cost, not the full social cost including pollution damage. As a result, the product is cheaper in the market than it should be from society perspective, and output is higher than the socially efficient level. This mismatch between private and social costs is a textbook example of market failure, confirming option A.

Why Other Options Are Wrong:
Option B describes a firm exiting because it cannot find buyers; in competitive markets this is a normal outcome of consumer choice, not necessarily a failure. Option C indicates that some consumers cannot afford a product, which is a distributional issue, not automatically a market failure in efficiency terms. Option D, producer surplus maximised, generally indicates an efficient competitive equilibrium, not failure. Option E describes normal profit conditions, again a sign of long run equilibrium rather than failure. Only option A clearly matches the economic definition of market failure where market prices do not reflect full social costs.

Common Pitfalls:
Students sometimes label any undesirable outcome as market failure, even when the market is efficient but results are unequal. Economic theory distinguishes between efficiency (market failure) and equity (fairness). Another pitfall is to think that every business closure is a sign of failure, when in fact entry and exit are part of efficient market dynamics. In exams and interviews, emphasise that market failure occurs when the market outcome is inefficient due to externalities, public goods, information problems or market power, and use examples like pollution to illustrate the concept.

Final Answer:
An example of market failure is when prices do not reflect the full social cost of production, so the market outcome is inefficient for society.