Market fails when the market outcome is different from the socially optimal outcome. One example of market failure is when there is negative externality associated with pollution. If firms do not internalize the negative externality, then they will only consider the private cost in their production decision, which is lower than the social cost. As a result, the market tends to produce more pollution that the socially optimal amount.

In this case, government could correct for the market failure by taxing firms. The taxes force the firm to internalize the social cost of pollution, and will induce the firms to reduce production and pollution to the socially optimal level.