According to mainstream economic analysis, a market failure (relative to Pareto efficiency) can occur

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for three main reasons.

 First, agents in a market can gain market power, allowing them to block other mutually
beneficial gains from trades from occurring. This can lead to inefficiency due to imperfect
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competition, which can take many different forms, such as monopolies, monopsonies, cartels,
or monopolistic competition, if the agent does not implement perfect price discrimination. In a
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monopoly, the market equilibrium will no longer be Pareto optimal. The monopoly will use its
market power to restrict output below the quantity at which the marginal social benefit is equal to
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the marginal social cost of the last unit produced, so as to keep prices and profits high. An
issue for this analysis is whether a situation of market power or monopoly is likely to persist if
unaddressed by policy, or whether competitive or technological change will undermine it over
time.
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 Second, the actions of agents can have externalities, which are innate to the methods of
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production, or other conditions important to the market. For example, when a firm is producing
steel, it absorbs labor, capital and other inputs, it must pay for these in the appropriate markets,
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and these costs will be reflected in the market price for steel. If the firm also pollutes the
atmosphere when it makes steel, however, and if it is not forced to pay for the use of this
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resource, then this cost will be borne not by the firm but by society. Hence, the market price for
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steel will fail to incorporate the full opportunity cost to society of producing. In this case, the
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market equilibrium in the steel industry will not be optimal. More steel will be produced than
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would occur were the firm to have to pay for all of its costs of production. Consequently,
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the marginal social cost of the last unit produced will exceed its marginal social benefit.
 Finally, some markets can fail due to the nature of certain goods, or the nature of their exchange.
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For instance, goods can display the attributes of public goods or common-pool resources, while
markets may have significant transaction costs, agency problems, orinformational
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asymmetry. In general, all of these situations can produce inefficiency, and a resulting market
failure. A related issue can be the inability of a seller to exclude non-buyers from using a product
anyway, as in the development of inventions that may spread freely once revealed. This can
cause underinvestment, such as where a researcher cannot capture enough of the benefits from
success to make the research effort worthwhile