Resource allocation
Efficient mix of goods and services
Economics is the social science that studies how scarce resources are used to produce goods and services. Economists usually say that economy is efficient when resources are used to produce the goods and services that are the most valued by consumers. So, one of the most important role of government is to observe whether this aim is achieved and if necessary intervene to improve the efficiency.
These situations under which economy is inefficient are called market failures. Under market failure, resources are used inefficiently in a sense that some goods are overproduced and some other goods are underproduced. For example, if the production of some good generates environmental damages (i.e. waste), it will be overproduced because the consumer of this good does not bear the cost arising from environmental effects. The reason is that while the producer does not bear environmental costs these costs are borne by the society as a whole (this is why economists call these costs external costs). As a result the market price does not reflect the true cost of this good and quantity demanded of this good is too high. In economic terms it means that the cost of producing the last unit of this good exceeds the benefit this last unit of good generates.
This is only one example about how the price system fails to work. Economist call these types of market failures negative externalities. There are also other typical failures such as positive externalities, public goods, information failures etc. However, the thorough analysis of these failures stays above the scope of this learning object.