Market Failure, Regulation, and Invisible Gorillas

Abstract The market failure argument is one of the conventional arguments for government regulation of the market. It holds that private transactions can generate negative externalities—costs to third parties that the transacting parties do not take into account. As a result, the government must regulate the market to prevent transactions where such costs to third parties are great enough to render the transaction socially detrimental.

This chapter argues that this argument is flawed to the extent that it ignores the regulatory effect of common law civil liability. When revised to take this into account, the market failure argument provides a much smaller scope for government regulation of market transactions.