Externalities impact market outcomes from "summary" of Principles of Economics by Saifedean Ammous
Externalities refer to the costs or benefits that affect individuals or parties not directly involved in a market transaction. When externalities are present, the market outcome is not efficient because the price does not reflect the true social costs or benefits of production or consumption. Negative externalities occur when the production or consumption of a good imposes costs on third parties. For example, pollution from a factory imposes health costs on surrounding communities. In this case, the market price of the good does not include the full cost of production, leading to overproduction and a socially inefficient outcome. Positive externalities, on the other hand, occur when the production or consumption of a good benefits third parties. For example, education provides benefits to society beyond the individual receiving the education. In this case, the market price does not reflect the full social benefit, leading to underproduction and a socially inefficient outcome. When externalities are present, the market fails to achieve allocative efficiency, where resources are allocated to their most valued uses. As a result, government intervention may be necessary to internalize the external costs or benefits and correct the market outcome. Policies such as taxes, subsidies, regulations, or property rights can help internalize externalities and align private costs or benefits with social costs or benefits. By internalizing externalities, the market can achieve allocative efficiency and maximize social welfare.- Externalities play a significant role in shaping market outcomes by affecting the true costs or benefits of production or consumption. Failure to account for externalities can result in market inefficiency, highlighting the importance of addressing externalities through appropriate policy interventions.
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